Options Trading Basics
Jun 05, 2018
I’m seeing more farm producers take interest in options trading. Why? For one, cash flow is tight for most producers, and in buying options there is a set expense. Second, risk management is most challenging—and important—when pricing opportunities are floating around break-even. Options are a tool that are valued but not always understood.
Due to popular demand, we covered options this week in Brock Market Edge, a service offered through Brock Associates. David Behrel, Vice President of Brock Investor Services, covered pros and cons for new learners. I want to share the highlights that stuck out to me from a producer perspective, and the conversation I would have to myself when considering each.
Buy a put to lock in a floor price. For example, I want a $4 corn put in case corn falls to $3 at harvest.
Buy a call to lock in a ceiling price. For example, I want a $4 call in case I have to buy feed at $5.
Buy a call and sell to elevator. For example, sell 5,000 bushels of corn at $4 at the elevator while simultaneously buying a $5 call option for 5,000 bushels. Why? You lock in $4 corn while also capturing part of a late summer rally. What if there’s no rally? Your call will only cost the amount for which you bought it.
More complicated strategies:
Short-dated, serial, or weekly options. These are more short-term options contracts. For example, I want to defend a short futures positions during a week in mid-July because I expect a weather rally.
Buy ATM put and sell OTM call. Buy a put to lock in a floor price at say $4 corn. To help pay for this position, I will sell a call at $5. I don’t expect corn to reach $5, so I have the protection without buying a full priced option (which can be expensive).
Are you still confused? Don’t beat yourself up. One of the hardest things about learning options strategies is there are SO many. In comparison, futures contracts are very straightforward; the price is x and I can buy or sell. With options, you can choose a variety of expiration dates and price levels. Then on top of that, you can use more than one to create a spread. They can be great tools, but are tough to follow sometimes because there are so many ways to use them.
The key to watch with any marketing strategy is the risk-reward. There are no free rides. Buying a put, for example, can be very expensive. A $10.40 November soybean price floor (put) could cost around 50 cents. That’s why some would choose to also sell an $11 call for around 30 cents. This makes the $10.40 put from 50 cents to 20 cents. BUT, you have to margin the short call position, and selling options creates a marginable position.
I recommend using a broker with experience in options if you’re new to it. It’s necessary to understand the basics, but also helpful to use a trusted individual to find a strategy. More producers are looking to use multiple marketing tools in a time when solid risk management is keeping the business afloat.
Want more info? We have a full staff of brokers and consultants that are happy to answer any questions you might have about an options strategy. Feel free to call the Brock office at 800.558.3431 or call me directly at 270.309.0156. Shoot me an email at email@example.com if you would like a link to the video.