As shown by the examples, option hedges do not provide identical results in rising and falling markets, are sensitive to the length of time they are held, and generally require more active management. In addition, the premium paid for the option has a large bearing on the final result obtained from an option hedge. However, for some hedgers these characteristics are more than compensated by the additional flexibility that options can provide.

For example, many users rely on a strategy called a “fence” to reduce the net cost of the premium on the hedge and enhance the hedging results. In this strategy, the hedger sells out-of-the-money call options and applies the premium received from selling call options to help offset the premium paid for the put options.

Another popular option strategy is “rolling” puts to higher strike prices as the market rises, selling back previously-purchased lower-strike puts and buying new higher-priced puts. When prices eventually turn lower – as they will if the markets behave like they have in previous short-crop years – the hedger will have established a selling price near the market peak.

While all these approaches involve some degree of risk, hedgers should consider options as one of the ways they can take advantage of the high prices currently being offered for harvest-time futures contracts. The services of a trusted broker or other financial advisor can be extremely useful in tailoring a plan that fits the risk profile and financial needs of each individual hedger.

Read the article at farmdocDaily.