Buying calls is gambling

Markets remained range-bound last week. There was some discussion the Chinese, who control much of the world’s corn carry out, may grind some for ethanol. Generally China has avoided the food versus fuel debate, but some of their corn is from 2010 and is declining in quality. If China would increase ethanol production, it could help drive futures higher as they will look to replace their inventories.

On the weather-front, the University of Illinois just released a study showing there is practically no correlation between winter precipitation and the following summer’s rainfall. Some will continue to be concerned that El Nino will eventually become a La Nina event. The extreme weather forecasts for this El Nino didn’t happen quite as planned. So, La Nina’s potential effects will remain uncertain.

This week most farmers will finish harvest. In general, elevators across the Midwest took in less priced grain this year than last harvest, mainly because of reduced prices. This may put pressure on the market as farmers have a stronger grip on their grain than most anticipated, as witnessed by stronger than normal basis levels around the country. I expected end users to be better prepared this year for a lack of farmer selling off the combine. Many bought tail-end 2014 crop right before harvest, while others stored piles of grain to guarantee product was on-hand. However, many end users are only covered until the new year, after that, we’ll see.

I’m expecting each end user to buy grain at different times throughout the year. This will offer farmers opportunities at varying times and locations. The best local bid will constantly change, forcing farmers to be vigilant. Savvy farmers are planning sales well in advance. Cash prices may be flat this year, so it’s important to remember that basis and futures could work independently and possibly directly opposite of each other. Farmers who look at both basis and futures prices individually will see the biggest chance of potential profits.

Selling calls

I’m frequently asked: Why do you sell calls instead of buying them?

Interestingly, many farmers have only been shown how to buy calls (i.e. the right to buy grain at a certain price). Conversely, selling a call is giving that right to someone else to buy grain at a set price. That “right” costs money to the buyer, a small premium (which varies) according time and price levels.

As a producer I know I will always have more corn to sell in the future. In other words, I’m always long corn. If I buy calls, it gives me the right to buy corn at some point in the future. Since I know I will always have more corn, why would I buy more? If I did buy more corn, it would likely shift my marketing strategy into speculating, which I never want to do with my farm operation. Speculating is gambling and gambling adds risk. I always want to minimize my risk exposure. If I wanted to gamble, there are easier ways than gambling on my production profits. The goal of my farm operation is to produce grain and sell it for profit.

Why is buying calls gambling?

The chance of making money when buying calls is about as likely as winning playing keno (the worst odds in a casino). When you buy calls you are buying time. The further out in time you buy a call, the more money it will cost you. Which means, the more you need the market to move. There are extremely smart people who have crunched the numbers using complex algorisms to determine exactly how much those calls are worth. Why would you bet against these smart people and their computers? As time to expiration gets closer, the value drops quickly. This is why many farmers tell me that they used to buy calls, but didn’t understand why they seldom made money over the long run.

Largely I’m against buying calls for my farm operation. However, there are always exceptions to the rule. Two that come to mind are:

• Protecting a sale before harvest from production issues.
• Inverse markets after harvest in which the nearby futures contract is higher than further out months in the same marketing year.

Many people like to buy calls because they are easy to understand and they can make people feel like they have a chance to hit a home run. But in marketing grain, I find simple isn’t always the best for my operation. To use the baseball analogy, I never want to “strike out” reaching for home runs. Instead, I want to get on base every time….with singles and doubles.

Jon grew up raising corn and soybeans on a farm near Beatrice, NE. Upon graduation from The University of Nebraska in Lincoln, he became a grain merchandiser and has been trading corn, soybeans and other grains for the last 18 years, building relationships with end-users in the process. After successfully marketing his father’s grain and getting his MBA, 10 years ago he started helping farmer clients market their grain based upon his principals of farmer education, reducing risk, understanding storage potential and using basis strategy to maximize individual farm operation profits. A big believer in farmer education of futures trading, Jon writes a weekly commentary to farmers interested in learning more and growing their farm operations.

Trading of futures, options, swaps and other derivatives is risky and is not suitable for all persons. All of these investment products are leveraged, and you can lose more than your initial deposit. Each investment product is offered only to and from jurisdictions where solicitation and sale are lawful, and in accordance with applicable laws and regulations in such jurisdiction. The information provided here should not be relied upon as a substitute for independent research before making your investment decisions. Superior Feed Ingredients, LLC is merely providing this information for your general information and the information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision. The contents of this communication and any attachments are for informational purposes only and under no circumstances should they be construed as an offer to buy or sell, or a solicitation to buy or sell any future, option, swap or other derivative. The sources for the information and any opinions in this communication are believed to be reliable, but Superior Feed Ingredients, LLC does not warrant or guarantee the accuracy of such information or opinions. Superior Feed Ingredients, LLC and its principals and employees may take positions different from any positions described in this communication. Past results are not necessarily indicative of future results. He can be contacted at jon@superiorfeed.com.