How Calls, Puts Work for Farmers
Jul 31, 2017
Loyal viewer Linda Miller lobs a dangerous question my way.
"Market analysts constantly recommend calls and puts to help producers take out some of the risk in commodity prices. How often does the call or put actually pay out for the farmer? On the other side, is it just the analysts that come out ahead?"
Linda, send me an address for your mug.
This is one of those debates where theory and practice don't overlap as much as you think. Options like puts and calls, which are essentially the right to buy or sell the underlying contract at a given price are most frequently recommended in concert with cash market actions to act as insurance against market moves.
For example, I can make a profit if I sell corn for $4, but I'm reluctant to do so because the market might go up. I could sell the corn when it hits $4 and buy a $4 call for x cents a bushel that will rise in value if the market does go up.
The theory here is this helps me actually pull the trigger. I get my $4 corn and if the market goes up, I can take advantage. If the market doesn't, I am out the option cost of x cents, but I still have corn sold for $4.
Looked at this way, options are only part of how much money you make. They are often compared to insurance, and you don't expect to make money on your car insurance, after all.
Properly executed options should not be expected to consistently generate income, but protect income from cash sales.
As I said, that is the theory. In practice it takes considerable self- discipline to stay happy with constant losses in your trading account. And more often than not, this very simple cash sale and options linkage evolves into more complicated or even speculative trading in an effort to have your protection cake and eat it too.
I speak from experience. As is constantly repeated most options expire worthless, but that doesn't mean they haven't helped the customer make money.
It may seem like the analysts are the biggest winners, but if your option program doesn't help your profit picture, for whatever reason, farmers will stop using both options and the analyst.