Sep 03, 2009
This week’s column is by JC Hoyt, Director of Risk Management at Cash Grain Bids. JC has been playing the GrainClass.com trading game, which gives producers a chance to try out trading strategies in real market conditions. To learn how you can try your hand at grain trading and risk management for your crop, visit GrainClass.com.
My goal with this game is to get $5.00 for my corn. On the one hand, I could “hope” that the market gives me the chance to price at $5, but when the game started the price was $4.15 – I was already behind the 8-ball! So I needed to be creative about using the marketing tools and market movements to help me achieve my $5 goal.
Here’s the outline of my game plan:
- Timeline for achieving my goal is June 1 to Oct. 1
- I want to achieve this with the least amount of trades (lowest commission possible to not eat up much of my money)
- I want to have little or no margin calls
What I know on June 1 at the time of implementing this strategy:
- Planting was delayed in the Eastern Cornbelt
- Wet conditions were prevalent in the Red River Valley of North Dakota
- The economy was in the tank
- History favors lower prices between June and October; on average, the futures market has fallen about $1 a bushel over this time period.
What I did not know but which materialized over the course of the next three months:
- Heat would be lacking during the growing season, especially in the Eastern Cornbelt
- The economy would be improving
- Crop conditions were at least on par for normal, perhaps better than normal
Now, every year we plant a crop with the full intent to harvest it, and sure, weather plays a big part in that, just like the hailstorms, drought and rain. But weather is local, just like my prices are – out of my direct control. I choose to take control over my prices by utilizing markets like futures and options in conjunction with my local cash pricing to get the price I need.
I am using a very simple marketing strategy to achieve my $5 goal with limited commissions and little to no margin risk.
Step one – Price the cash crop as high as possible (all the cash crop). Remember, no yield risk here.
- I sold my 100,000 bu. of corn for my local bid average cash price of $3.39
- Made cash sale from the range of $4.14 high to $2.98 low
- Date range of sells 6-3-09 to 7-14-09
Step two – Enhance step one with buying a put option as close to the money strike price as what you achieved in step one. In essence, I’m selling it twice – once in the cash market and once again with puts.
- Purchased the December $4.50 puts for $0.48 and the December $4.00 puts for $0.37
- I wanted to get the highest floor I could without being in the money on the strike price
- This strategy is designed to work if the market goes lower and will not work if the market goes higher
- The lower the market works, the higher my net cash price will become
- Cash price + put option premium improvement in option price = higher net cash price
- Remember, this is to enhance or to add value to my cash price sold
- If I had a yield risk, I would buy the puts first and price my cash in a way that would lay off my yield risk (i.e., make cash sales in percentage levels at price levels “20% cash at planting, 30% cash sale if futures gets to $4.50, 10% cash sale to get up to 65% level of my crop insurance coverage, etc….”)
Step three (optional) – Sell a call option to pay for step two.
- Keep in mind that anytime you sell an option, you have risk of a margin call
- If you do want to do this step, pick the strike price that is close to equal value of the premium that the put cost (looking for $0.48 or $0.37 premium level)
- I sold a $4.00 December call for $0.44
- The most I can make off this call option is the $0.44 I sold
- The most I could lose on this (aka margin call) is unlimited
Where do I stand today? Based on market prices on Sept. 3, I’ve got a price of $4.78. While a bit shy of my $5 goal, I’m still well above any price I could have achieved by sitting and waiting for the market to “give” me the price I want. Today’s cash price is at $2.93, and given what we see, looks like it will only get worse between now and harvest -- and if so, my bottom-line price from my strategy will continue to grow.
Of course, the market worked in my favor here. Lower prices helped me with my long puts and short calls. If the market had gone higher, say from a widespread drought this summer, this strategy would have taken a huge hit. The key to successful trading is to have a plan that coincides with your market outlook but to change your trades using limits and stop losses if market conditions change.