Risk Management with Insurance Tools
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Do you really want to use Puts?
Sep 05, 2012
The markets are facing some critical periods in the near future. The September 12 USDA Supply and Demand report is the next big hurdle the bulls are going to have to face. Odds are that the market is going to disagree with many aspects of this report but ultimately they probably have as good if not better idea of the situation as anyone.
One of the areas that should to be watched carefully is the 2011/12 ending stocks in corn. Data suggests that we could see that old crop ending stock over 1 billion bushels. If that is the case than maybe the markets will focus more on demand reduction rather than demand destructions if it is not already too late. If that is the case then there is a case that corn at this prices will do its job and will only need to maintain these levels for a limited period of time. With corn harvest at 10% throughout the US we are going to see corn yields come in daily. The thought process is that the earliest planted corn is going to show the worst yields.
I receive many calls from farmers that want to lock in current corn price level for crop insurance purposes. The spring price was set at $5.68 and the market is trading around $7.95. That is a difference of over $2 per bushel. This is especially important as there are many producers will be either buying out of contracts or having to buy corn on the market to meet their previously made contracts. I talked to a producer the other day in WI and it is going to cost him $3 per bushel just to get out of some of his contracts.
Although I lean towards using futures to lock in these price levels the majority of the calls I get are regarding buying puts to lock in prices. What surprises me is the number of people that do not have much working knowledge of those puts they want to utilize. Many factors weigh into using puts such as the costs of puts and the fact that you need to buy 2 puts for every 1 future to cover roughly the same amount of bushels depending on the current delta. Other factors will determine the performance of that put such as time decay and volatility. Another theory with puts is that you can roll them up if prices go higher. On paper it might be nice to say you sold your corn near the top of the market but you also need to realize how much money you invested into rolling those puts and how far down from the high strike price do you need to go before that put value will start to kick in. If prices stay up near these levels through the October Harvest Price discovery for corn than you have lost all the value of those puts you purchased.
If you have questions regarding puts vs. futures or disagree with me feel free to contact me at 707-365-0601 or email me at Jamie@GulkeGroup.com.
There are substantial risks involved with both futures and options trading. While risk is limited to purchase price when buying an option, it is not limited when selling an option. Commodity trading and other speculative/ hedging investment practices involve substantial risk of loss. Past results are not necessarily indicative of future results when utilizing the commodities markets. This material and any views expressed herein are provided for informational purposes only and should not be construed in any way as an endorsement or inducement to invest.