A look at buying puts

By Jon Scheve, Superior Feed Ingredients, LLC

The market is monitoring increased COVID lockdowns in China and South America’s weather forecasts for their upcoming growing season. Also, recent bombings in Ukraine have reduced the electric power supply by 50%, which is impacting export facilities and their ability to move grain. The Black Sea export corridor deal was renewed on Nov. 19, but the total ships loading in Ukraine has dropped by half since then.

I shared previously that on April 19 I bought $6.80 December puts for 40 cents on 70% of my 2022 production. This basically provided me a guaranteed floor price of $6.40 per bushel, after factoring the cost to buy the puts.

Why did you buy puts?

There were several variables impacting the market at the time. The war in Ukraine was only two months old, plus there were concerns in the western corn belt regarding late planting and that La Niña could cause widespread dry weather. Generally, upside potential seemed higher than the downside risk, but to be safe I bought these puts as an “insurance policy” that guaranteed a very good profit for the year if the market pulled back, like it did in 2019. With the dry weather I was experiencing on our farm at the time I was leery of selling more corn for fear our production could be down significantly. 

What happened next?

It turned out, the day I bought the puts December corn futures traded to $7.55 and that was the fifth highest trading day of the year for December futures. December corn would later peak on May 16 at $7.66. However, in June, corn futures fell $1 per bushel in 4 trading days, so I was glad I had purchased the $6.80 puts as protection.

What did you do then?

After discussing my options available in June with several trusted individuals, on June 23 when December corn had fallen back to $6.50, I sold these $6.80 puts for 70 cents and collected a net of 30 cents profit on the trade (70 cents less the 40 cents I originally paid). At the same time, I bought $6.10 December puts for 30 cents. After the two trades, I had a $6.10 floor price for $0 cost, instead of a 40-cent cost on the $6.80 puts that left me with basically a $6.40 floor price.

Why did you make this trade?

At the time I thought December corn priced for less than $6.50 was undervalued, and corn rallying to $7 again was likely. The following summarizes how much I would be ahead or behind, if I did not make this trade, based upon December corn’s price at Thanksgiving:

  • Above $6.80 — 40 cents ahead with the trade
  • Between $6.40 to $6.80 — Ahead somewhere between 1 cent to 40 cents
  • Between $6.10 to $6.40 — Behind somewhere between 1 cent to 30 cents
  • Below $6.10 — behind 30 cents maximum

In the end I looked at the potential outcomes of the trade and found that if the market went up or sideways, I would be ahead. I would only lose a maximum of 30 cents if the market went down which meant that I had basically a 66% chance of this trade being the right decision and I had limited downside exposure even if I was wrong.

I was concerned that if I did not take the profit from the $6.80 puts and buy the $6.10 puts, and the market rallied, I would have to subtract the 40-cent cost of the original $6.80 put protection from my final sold price down the road. Using the profits in the trade to buy the $6.10 puts provided a profitable floor price if I was wrong and corn values continued to trade lower. I consider the new trade free “catastrophic price insurance.”

What happened?

At December options’ expiration, December corn closed at $6.67, so the $6.10 put options expired worthless. If I had kept the $6.80 puts in place, they would have only been worth about 13 cents at expiration. That means I would have lost 27 cents versus the trade I made above, so I am happy with the outcome.

Current position

I no longer have any floor protection in place for most of my crop. Since corn prices usually, but not always, rally from the end of harvest through winter, I am taking a “wait and see” approach with my remaining unpriced 2022 production.

Today I am 10% sold with futures at $6.40 on the 2022 corn crop. I also have 10% of my 2023 crop priced with futures at $6.25, but this sale could be moved back against the 2022 crop year if I want.

Please email jon@superiorfeed.com with any questions or to learn more. 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.

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