Jerry Gulke: Reown with Calls? Buy or Sell?

07:00AM Nov 18, 2019
Options have two purposes: to re-own sold grain (call options) or to put a floor under prices (put options).
( AgWeb )

Options have two purposes: to re-own sold grain (call options) or to put a floor under prices (put options). Options for grains can be defined as the “right” to own or sell but not the “obligation” to deliver. 

Analysts recommend puts or calls, but we rarely hear a price outlook associated with this rationale. Why would I pay good money to re-own a product that doesn’t have good fundamental rationale for going higher? Rather, I often sell calls for the premium. 

Food for Thought

Are prices high or low relative to supply and demand limits? To answer, I develop a price based on supply and demand and compare it to current prices. 

Adequate-to-surplus situations, like we have now, create a market “carry,” where futures prices are higher for further-out deliveries. As of Nov. 9, for example, July corn futures were 21¢ higher than December, and a July $4 call option cost 21¢. That begs a few questions: 

  • What would make me believe corn has a 42¢ rally potential given current fundamentals?
  • Will my corn be more or less competitive 42¢ higher? Can corn “earn” that kind of carrying charge? 

The same can be said for July soybeans that were trading 46¢ higher than November. An at-the-money July call cost 41¢ on Nov 9.

What in the outlook suggests soybeans will be worth paying 41¢ for the right to re-own until July for another 46¢ in market carry?

Focus on Profit

The answer(s) varies with one’s personal beliefs, but to take the advice to re-own without a common-sense outlook is dangerous. On-farm storage can be another profit center if used correctly to capture the carry by hedging off far-out future contracts. This is what an elevator does. A do-nothing plan can be costly as well. 

A look ahead shows the cost of a $4 December corn call option or a November $10 soybean call option were 26¢ and 40¢, respectfully. Knowing what you know today, do $4.26 and $10.40 prices per bushel look attractive?

The beauty of using the 75-year-old tools of risk management is that it offers flexibility to change direction if conditions merit while maintaining beneficial interest in a crop not yet grown or committed to an entity.

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Jerry Gulke farms in Illinois and North Dakota. He is president of Gulke Group. Disclaimer: There is substantial risk of loss in trading futures or options, and each investor and trader must consider whether this is a suitable investment. There is no guarantee the advice we give will result in profitable trades. Past performance is not indicative of future results.