TOP FARMER WEEKLY PERSPECTIVE 7/17/20 BY BRYAN DOHERTY
Feed buyers and Grain Sellers, When to Buy Call Options
When should you buy a call option? A call option gives you the right to own futures, without the obligation. Therefore, you would buy a call option If you believe the market is going higher, right? Well, maybe. Often call options are purchased by feed users or farmers after they’ve sold grain. Yet, they may not necessarily believe prices will go higher. By selling grain, their belief is that prices will probably work lower and that the best way to shift risk was to sell cash grain. By owning a call option, they can participate in a price rally. In the end, what they have done is create what we term a balanced approach; shifting cash market risk by selling, and then re-owning with a fixed risk tool. Feed users may buy call options for protection from higher prices, while believing that prices will probably go lower. A trader, other the other hand, will buy call options, believing futures prices will appreciate, expecting to make money.
As you can see, there are different reasons or uses for call options. In this Perspective, first we will take the view of a grain and livestock producer. For grain producers, selling is often a source of anxiety, especially if prices are rallying. By not selling, you have been able to witness your inventory or crop value appreciate. When you do sell, if prices move higher, you are led to believe you’ve made some type of mistake or error in judgment. That is only human nature. To get around that feeling of mistake or error, purchasing a call option after you sold grain is a great way to participate in the market. Your risk is fixed. Sometimes producers may buy call options before selling their grain. The rationale here is that when prices rally, you’re able to more comfortably sell your cash grain, already having re-ownership in place. The risk with this position is if prices do not rally. Then your cash grain is worth less and your call option is losing value.
A feed buyer would buy a call option to shift risk for future feed purchases. If prices move higher, he may end up purchasing feed at a higher price. If his call option appreciates in value, he can use these dollars to help offset cash purchases. If prices go lower, he will end up buying grain for feed at a lower price, and his call option could lose all its value. The key, however, is that the risk or investment in a call option is fixed. Regardless of price movement, you know approximately how much you will be spending to buy feed.
As grain and livestock producers know, summer markets can be extremely volatile. One-week forecasts for drought send prices sharply higher and the next week, prices are declining as forecasters change their view. Our point is that it is very difficult to outguess weather and market movement. In addition to weather, there are USDA reports, political developments, and other variables you just can’t account for that could affect price. This year is a perfect example. Who saw Covid-19 or an energy price war? We encourage the use of strategy that incorporates a mix of marketing tools. A call option is a powerful tool to shift risk and allow you to take advantage of market opportunities. Before using a call, make sure you understand the risks associated with it as well as its potential. Talk to the right people than can help you properly execute and monitor your position.
If you would like help utilizing call options in your operation, call Bryan Doherty at Total Farm Marketing. You can reach him at 1-800-top-farm, extension 444.
Futures trading is not for everyone. The risk of loss in trading is substantial. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Past performance is not necessarily indicative of future results.
Author
Bryan Doherty