Option spread protection trade

There was little news during the holiday week. Highlights:

  • South American weather conditions remain good, but dry weather could still have an impact
  • EPA increased renewable fuels, should cause increased demand for soybeans and corn
  • Goldman Sachs issued their first commodity buy order in over four years, which may help grain prices long-term

Corn remains in a tight 25 cent trading range. Farmers aren’t selling at the low end of the range, which helped prices this week. However, any selling by farmers will likely keep a ceiling in place.

Beans continue to rally despite adequate world stockpiles. Some funds are analyzing macro markets and using beans as an inflation hedge. Long-term markets can’t dissociate from fundamentals. For the rally to continue into 2017 a supply distribution is needed.


Market Action

On the final trading day for Dec ’16 options, I had 13 different options working. With so many trades, it’s very important to record details of each trade, including goals and strategy. Then when the market moves significantly several months later, I can objectively determine the merits of each trade. This helps me plan for future trades and marketing strategy. Following shows how these options played out, along with my original goal and strategy notes:


Calls Sold for the Premium

  • Trade Detail:

◦                     9/15/15 – Dec corn was trading $4.18 I sold a Dec $4.80 call for 18 cents

◦                     3/24/16 – Dec Corn was trading at $3.87 I sold a Dec $4.40 call for 15 cents

◦                     6/6/16 – Dec corn was trading at $4.30 I sold a Dec $5.00 call for 10 cents

  • Goal – Calls placed hoping futures would rally and hold above the levels at that time
  • Potential Benefit – Regardless of price outcomes I keep the premium and make the sale at stated prices.
  • Potential Concern – Prices would fall substantially and a price level could be missed.
  • How Much – 15% of 2016 production (5% each sale)
  • What does this mean now that the options expired?

◦                     I keep the premiums and no sales transpire

◦                     Corn never traded above 2 of the 3 strike prices, so very little opportunity was missed

◦                     I am pleased with these trades and will apply the profits to future trades


Option Spread Protection #1

  • Trade Detail on 3/30/16 (the day before the USDA 3/31 report)

◦                     Bought a $3.90 put and sold a $3.50 put for 20 cents

◦                     Sold a $4.30 Dec call for 18 cents to offset put spread cost

◦                     With brokerage commissions this trade cost 3.5 cents and expired the day after Thanksgiving

  • Goal – Assuming corn is range bound $3.50-$4.20 through Thanksgiving and I wanted to capitalize on this.
  • Potential Benefit – The trade gave me immediate downside protection with some upside potential
  • Potential Concern – A large price swing in either direction would make this trade less profitable.
  • How Much – 5% of 2016 production
  • What did this mean?

◦                     Between $3.50-$3.90 — receive $3.90 for my corn

◦                     Below $3.50 – I keep 40 cents of premium to apply to a future trade

◦                     $3.90 – $4.30 get whatever price corn is trading

◦                     $4.30+ only get $4.30 regardless how high corn goes


Option Spread Protection #2

  • Trade Detail – 4/8/16 corn was $3.75

◦                     Bought $3.70 put

◦                     Sold $3.30 put for 17 cents

◦                     Sold $4 Dec call for 18 cents (help offset spread cost)

◦                     With brokerage commissions – trade cost less than .5 cents and expires near Thanksgiving

  • Goal – Assuming corn is range bound $3.30-$4.00 through Thanksgiving and I wanted to capitalize on this.
  • Potential Benefit – This gave me immediate downside protection and with some upside potential
  • Potential Concern – A large price swing would make this trade less profitable.
  • How Much – 5% of 2016 production
  • What does it mean?

◦                     $3.30-$3.70 – I get $3.70 for my corn

◦                     Under $3.30 – I keep 40 cents of premium to apply to a future trade

◦                     $3.70-$4.00 – Get the price corn is trading

◦                     Above $4.00 – Only get $4.00 no matter what

***With both transactions in place I have to subtract 2 cents from the final price of both to cover the cost & brokerage of placing both trades.***


Summary of Option Spread Protection Trades #1 and #2

  • Corn closed at $3.49 on Friday.
  • What does this mean?

◦                     Trade #1 – Price below $3.50

▪                                       No Sale

▪                                       Take 40 cent profit and add to trade #2

◦                     Trade #2 – Price is below $3.70 but above $3.30

▪                                       Sell corn for $3.70

▪                                       Add 40 cent premium from trade #1

▪                                       Minus 4 cent commissions

▪                                       Total price for corn on 5% of production = $4.06


Futures Sale with Straddle Sale

  • How much – 5% of 2016 production
  • Trade Detail:

◦                     Sell Dec Futures at $3.72

◦                     Sell a $3.50 Dec call & Sell a $3.50 Dec put for 48 cents worth of premium

  • Goal – on 7/13/16 price is $3.72. I think the market will trade sideways through Thanksgiving.
  • Potential Benefit – Substantial premium if prices stay below $3.72.
  • Potential Concern – I have to sell at $3.72 even if prices go above it. I don’t like this price, but I’m willing to accept it if the market rallies in an effort to take advantage of the potential premium I think is more likely happen.
  • What does this mean at Thanksgiving?

◦                     Under $3.50 – sell nothing but collect 68 cents premium ($3.50-$3.72 = 22 cents + 48 cents)

◦                     $3.50-$3.72 – Sold corn for $3.98-$4.20 (collect 48 cents at $3.50 and lose 1 cent for every cent above)

◦                     Above $3.72 – I have to sell 5% of my production for $3.72 and another 5% for $3.98

▪                                       BUT – I would move this sale to 2017 and collect an additional 35 cent market carry premium (available in the market today) and have a sale near $4.35


Straddle Sale Summary

Corn was hovering around $3.50 the Wed before Thanksgiving, so I decided to buy back the straddle for 5 cents.

  • What does this mean?

◦                     Originally sold the straddle for 48 cents, so I now have 43 cent profit

◦                     Added to the original $3.72 sale – I am now valued at $4.15 against Dec

  • I am VERY pleased with this trade. I thought there was a lot of potential, and I was rewarded for predicting the price of corn at Thanksgiving correctly.


Options Strategies

As you can see from the above trade summaries, there are several factors that I consider when developing every options strategy:

  • Goal – What am I trying to accomplish? This would include what I think the market is likely to do based upon marketplace variables (i.e. potential carryout, weather conditions, etc.).
  • Potential Benefits – What’s the most I can get from this trade? What’s the best case scenario? Does this best case scenario align with what I think the market will likely do?
  • Potential Concerns – What’s the worst that can happen from this trade? Am I willing to accept this outcome?
  • How Much – What % of my future production am I willing to commit to this goal?
  • Trade Detail – Do I fully understand what my profits/losses will be for every potential price point? Do I understand all timeframes I’m committing to? Do I understand all the risk?


Importance of Understanding Everything

Options are very useful tools, but can be extremely complicated if farmers don’t follow them all the time. Sometimes farmers will place options strategies that they don’t fully understand because an advisor recommends it. While the trade can go well, there will be times that it doesn’t and the farmer is left hanging. Even in some cases the trade may look like it did well, but the farmer does not realize how much risk their farm operation was subjected to.

I urge all farmers using options to ask the questions above for every trade they make so that they know exactly what to expect regardless of what the market does.

As you can see, I don’t put all my eggs into one basket when it comes to marketing my grain. I utilize many different trades throughout the year to diversify my marketing plan. Like in baseball, I always want to get on base, sometimes I may hit a home run, but I never want to strike out. Next week I’ll walk through the details of the remaining trades I had in place through Thanksgiving.

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.

Check Also

Farmer’s tax guide

By Barry Ward, Director, Ohio State University Income Tax Schools & Leader, Production Business Management …

Leave a Reply

Your email address will not be published. Required fields are marked *