Over 50¢/bu. to buy an at-the-money corn put option. How about $1.35/bu. for an at-the-money soybean put? No wonder there are complaints that options “are too @#&$ high.”
But the reality of today's highly volatile grain and other commodity markets translates into high-priced put and call options, which were cheaper a few years ago.
The question for growers is whether or not options can still be considered reasonable tools to manage risk. Scott Irwin, University of Illinois agricultural economist, thinks so, if the objective is not to use options to generate profits. For example, Nebraska grower John Swanson counts on options to help him protect prices on corn and beans already contracted at the elevator.
“If you really want to try to time your pricing and beat the market, options are probably not the tool to use. You might want to trade the futures directly,” Irwin tells Corn & Soybean Digest. “But even with today's high volatility, I don't believe options are biased toward either the buyer or seller.”
Swanson doesn't rely specifically on options to lock in profits. But he is open to additional profit with them. The McCook, NE, corn and bean grower leaves actual production practices up to those who share crop with him in a 50-50 corn-soybean operation on about 1,200 acres.
“But I do most of the marketing,” he says. “I try to have 80% of the crops protected by options. And we're waiting to get part of our 2011 production price protected when the opportunity is there.”
Part of his 2009 and 2010 crops were contracted with a regional elevator in 2008. Beans were priced at $13.20 for 2009, while 2009 and 2010 corn was contracted at $5.23 and $5.33. Those are strong prices. And with them secured, he felt comfortable spending 8¢/bu. on December 2009 $3.80 calls when December futures were near $3.
His goal was to take profits from calls if and when prices rallied. Swanson says he expected to roll those calls into 2010 if markets remained low up to their expiration.
“If corn rallies, the calls will yield profits,” says Swanson. “Those profits will go into an account I use for options trading and will be used to lock in higher prices for 2011.”
He will also contract corn with the elevator if the rallies occur. “If corn prices stay near $3, then I will have the options to fall back on.”
As for soybean options, even Swanson was reluctant to take the plunge. “Premiums on soybean options are too high to feel comfortable locking them in,” he says.
Swanson is prepared to take a loss on the corn options premium charges if options expire worthless, especially when he has the grain already contracted with the elevator. But for growers interested in using at-the-money put options to set a floor, he warns them to be ready to pay.
For example, an at-the-money December 2010 $3.80 put was priced at 56¢/bu. in late summer. With each contract at 5,000 bu., that's $2,800. To get that money back, the corn price would have to increase to near $4.40, depending on the time value of the option.
Even out-of-the-money puts are expensive, with the $3.30 put premium at about 30¢ and the $3.20 at about 25¢.
At-the-money November 2010 $9.40 soybean put options had a premium of $1.35. With the 5,000-bu. contract, that's a lot of money — about $6,700. November futures would have to hit $10.75 to break even on the option. Going out-of-the-money is less expensive, with a November $9 out at $1.07, and an $8.80 at 97¢.
Again, those high-priced puts reflect the volatility of the market. With a corn futures up or down limit of 30¢/bu. and soybeans at 70¢, numerous national or world happenings can ignite up or down moves, over and above domestic weather markets or changes in livestock feed demand.
A MIDDLE EAST uprising and bad China crop report can impact markets as much as Corn Belt cold, hot, wet or dry weather. If Iranian unrest causes crude oil prices to spike, ethanol, corn and beans may follow. If fund investors take stronger looks at commodities trades for their portfolios, corn and bean markets can be highly influenced. Thus, the volatility of futures prices and options for them is expanded.
“What has shocked farmers in the last few years is the expensive price of options premiums caused by the high volatility of the markets,” says Irwin.
“At issue is the approach farmers take in their marketing when they use options,” he says. “If their expectation is that their options activities should be a profit center rather than a risk-management center, those farmers are likely to be sorely disappointed.”
According to Irwin, “You have to separate those issues when you're confronted with the question: ‘Are options too expensive?’”
Irwin helped conduct a thorough study of corn, soybean and wheat options trades over a 20-year period through 2005. “Do options markets provide a fair price for the form or price insurance that's being offered? That's the question,” he says. “We found that if we consistently bought near-the-money options for every expiration over a 20-year period within 30-90 days before option expiration, grain options were priced very fairly.”
He advises growers wishing to enhance their risk management to look first at subsidized options offered through the USDA Risk Management Agency (RMA) crop revenue insurance programs, “which are now complemented by the ACRE program.”
Crop revenue coverage (CRC) and revenue assurance (RA) are two of several RMA tools growers can use to manage against lower prices. (For more on these and other RMA programs, go to http://tinyurl.com/CSD1009Options.)
“I don't believe enough farmers truly understand the interplay between the revenue insurance policies available through RMA and their marketing options,” says Irwin, noting that tying the two together can help growers better manage income.
“As you go through the marketing window, relative to those RMA options, ask yourself, ‘How do I want to complement that risk protection by using options, futures, hedge-to-arrives and forward contracts?’ That's my basic approach.”
THE HIGH PRICE of options can be lowered, but the risk is usually increased. For example, if the $3.80 put costs 56¢, you could sell a $4.80 call for about 26¢, lowering your cost of protection to about 30¢. But here is a $3.80-4.80 marketing window. If the market goes over $4.80, there can be margin calls.
The cost of protection can be lowered by selling a call closer to the $3.80 price. A $4.30 call would cost about 38¢, lowering the overall cost to under 20¢/bu. But the marketing window is $3.80-4.30. Still, if corn prices go above $4.80 or even $4.30, growers may not mind meeting margin requirements.
Irwin encourages growers concerned about using options to consult with their Extension economist or a marketing consultant.
Swanson says he realizes there is a price to pay for risk management. “But you can bargain-hunt when you see big moves in futures prices,” he says. “I may lose money on an options position, but I know the maximum I will lose from the beginning.”