Buying puts for price protection

By Jon Scheve, Superior Feed Ingredients, LLC 

Corn closed last week 3 cents lower than the week prior. In 65 of the last 67 trading sessions, December corn has closed between $4.70 and $5. One positive was that corn did not make a new low for the calendar year.

Beans, however, had a great finish to the week by breaking out to the high side to levels not traded since mid-September. This might be attributed to the weather conditions in Brazil that could be causing some traders a bit of concern. 

The Mato Grasso region in the north, where nearly 25% of Brazil’s beans are raised, has been hot and dry. While in the south, where another 25% of Brazil’s beans are grown, it has been very wet, which has delayed planting. However, there is a favorable weather window forecasted for next week that could allow for some planting advancement. Regardless, the southern areas still have until late November until delays would cause yields to be compromised while the northern areas are still early in the growing cycle.

Market action — Results for buying puts for price protection

I previously wrote that in late December of 2022 I sold 25% of my expected 2023 bean production at $14.04 with a November ’23 futures contract sale. 

At the same time, I also bought $13.80 Nov puts, which is the right to sell beans for a specific value at a later date, for 78 cents on my remaining 75% of production. To get the true hedge value protection of the trade, the $.78 put cost must be subtracted from the $13.80 strike price to get the actual $13.02 floor protection value.

Combined, these trades provided a guaranteed $13.25 futures price floor on my 2023 beans if there was a major market downturn. They also gave me unlimited upside potential, minus the cost of the puts, if the market rallied. When beans were trading down to $11.30 in late May, I was glad I had downside protection. However, two months later when beans were trading $14, I thought the cost of the puts might have been a waste. Regardless, having upside potential was always the goal for buying the puts instead of outright selling because no one can predict the weather.

Rolling my put price down

On Sept. 28, when November beans were trading at $13, I sold my $13.80 puts for 90 cents. As noted above, I previously paid 78 cents for them. I then bought November $12.80 puts for 20 cents to keep catastrophic downside protection in place for another month.

What does this mean?

My net cost to own floor protection was reduced from 78 cents to 8 cents. My floor protection was reduced from $13.02 to $12.72. Following are the calculations:

Bought $13.80 put: paid 78 cents

Sold $13.80 put: collected 90 cents

Net profit: 12 cents

Bought $12.80 put: paid 20 cents

Less 12 cent profit from trade above

Net cost: 8 cents

Why did you do this?

Historically beans tend to rally from early October to late October when the options expire. So, I basically reduced my floor cost, betting on another seasonal rally. While the seasonals suggested upside potential I feared that yields could be better than expected and it could drive the price of beans much lower during harvest.

What happened?

The market stayed range bound and finish at $12.97 when the options expired on Oct. 27. Those $12.80 puts I owned for 8 cents expired worthless and my floor protection was gone.

What if you had kept the $13.80 puts?

They would have been worth 83 cents at expiration, and I would have made a 5- cent profit. I paid 78 cents to buy them, and I could have sold them for 83 cents. Instead, I bet on a seasonal trade that did not happen and had a small 8-cent lost. 

Why didn’t you roll down the puts in May when prices hit $11.30?

I could have rolled the $13.80 puts down to $12.80 puts, collected a net 10 cents on the trade, AND kept a floor price. This would have meant 75% of my beans were protected at $12.90 instead of $13.02. 

I did not do this, because at the time bean prices were $2 per bushel below my floor protection price, old crop corn prices had just dropped from $6.50 to $5.50, and I didn’t have any of my 2022 corn sold. Because I was not confident bean prices would rally back $2 per bushel, I could not justify rolling my put floor position lower and potentially taking 12 cents per bushel less for my soybeans betting on a rally later in the summer.

Fortunately, beans AND corn rallied in June, and I sold the rest of my old crop corn for 70 cents higher than where prices were in late May. This meant my new crop beans missed out a little, but since I, like most farmers, grow substantially more corn bushels than beans, it still feels like a win.

Looking forward

With no more options in place, I now have only 25% of my beans sold at the equivalent of $13.80 against the November. This is figured by taking the sale I have in place at $14.04 and subtracting the 8-cent loss on the puts on the other 75% of production.

I am now looking for an opportunity to sell my remaining 75% of 2023 beans. 

Next week I will discuss what I did with the sales against the November futures contract.

Please email jon@superiorfeed.com with any questions or to learn more. Jon grew up raising corn and soybeans on a farm near Beatrice, Neb. 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.

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