• Skip to primary navigation
  • Skip to content
  • Skip to footer
StoneX®

Trade Futures, Spreads and Options with Confidence.

Top Navigation

  • Open a Futures Account
  • Sign Up
  • Log in
  • 1.800.800.3840

Primary Navigation Menu

  • About
    • Who We Are
    • Services
    • Risk Disclosure
    • COVID-19
  • Trade
    • Broker-Assisted
    • Self-Directed / Online
    • Request Pricing
  • Hedge
    • Ag Marketing Plan
    • WASDE Analysis
    • Grain Resources
    • Livestock / Dairy Resources
    • Request Pricing
  • Invest
    • Automated Strategies
    • Managed Futures
    • Request Pricing
  • Advisories
    • GENERAL / FUNDAMENTAL
      • DT Newsletter
      • Insider Market Advisory
      • Turner’s Take Newsletter & Podcast
    • TECHNICAL ANALYSIS
      • The Cullen Outlook
      • Data Feed Trade
      • Jarboe Trading Journal
      • Trade Spotlight
    • AG MARKETING
      • Cattleman’s Advisory
      • Technical Ag Knowledge
      • Turner’s Take Ag Marketing
    • THIRD-PARTY RESOURCES
      • CFRN
      • Moore Research Center, Inc. (MRCI)
      • OptionWorks®
      • TASMarketProfile.com
  • Education
    • CME Group Resource Center
    • CME Group Offers
    • Small Exchange Resources
    • Guides
    • Frequently Asked Questions
    • Order Entry Handbook
  • Blog
    • Futures 101
    • Ag Marketing
    • Tips & Strategies
    • Trading Advisories
  • Resources
    • Trading Software
    • Quotes and Charts
    • Futures Calendars
    • Contract Specifications
    • Margin Requirements
    • Futures Calculator
  • Accounts
    • Apply
    • Access My Account
    • Funding
  • Contact
 

Hedging by Purchasing Options: A Margin Free Way of Risk Management

May 10, 2011 by Drew Wilkins| Tips & Strategies

Talk with any hedger and they’re sure to tell you about an experience with trading on margin.  Margin is a good faith deposit that a hedger must have in their account in order to initiate a long or short futures position.  For example, the margin on a corn contract is currently $2,362.00.  This means that if you want to get into a corn futures position, your account must have at least $2,362.00.  In order to maintain the position, a hedger must meet maintenance margin requirements.  The maintenance margin requirement for corn is currently $1,750.00.  This means that the value of the hedgers account must always be above $1,750.00 in order to maintain the corn futures contract.  If the account value falls below $1,750.00, the hedger will be on a margin call.  The hedger will need to either deposit enough money in the account to get back to the initial margin area ($2,362.00) or liquidate the position to meet the margin call.  The hedger’s goal is to have their cash position hedged, so the logical decision is to meet the margin call and deposit funds into the account.

You can see how the above scenario can cause unneeded stress on a hedger.  Luckily, hedgers have the option markets as an alternative to an outright futures hedge.  This article will summarize how producers and users of commodities can purchase options for a margin free hedge.  If you aren’t familiar with how purchasing options works, see a previous article I wrote here: Options on Futures:  An Introduction to Buying Options.

Purchasing Options for Hedging

Purchasing options offers a margin free way to help roughly determine a price you will receive or pay for your commodity.  The costs to do this will only include the premium paid for the option plus the commissions and fees.  Purchasing an option for hedging has many of the same similarities of purchasing insurance on a vehicle.  Think about it, when you purchase insurance on a vehicle, you’re required to pay a premium for a certain time period of coverage.  The same applies to purchasing options on commodities.  You select a delivery month and purchase an option by paying a premium for the option.  The only money you have at risk is the amount paid for the option.  If the market benefits your cash position, the option will expire worthless and you will be out the premium paid.  The same applies to insurance on your vehicle.  If you don’t need to use the insurance, the coverage for that time period expires and you will be out the premium you paid for coverage.

Real-World Examples

John the farmer has 200 acres of corn he’d like to hedge.  Using an average of 150 bushels per acre, he expects he’ll have 30,000 bushels of corn to sell at harvest.  Given the recent rise in prices in the corn market, he wants to lock in a bottom price he’ll receive for a percentage of his corn.  He decides to hedge 50% of his crop, or 15,000 bushels.  He decides that the bottom price he’d like to receive is roughly $5.60 per bushel.  Since he will be selling his crop in October, he’ll need to use the December put options to hedge his position.  December futures are currently trading at $6.76.  Knowing that each put option represents the right to sell 5,000 bushels at a specified price; he knows he needs to purchase three options to achieve his hedge.  Options are quoted in cents, with each cent representing $50.  The current price for $6.00 puts is 40 cents, or $2,000 for each put.  John purchases three $6.00 corn puts for a total of $6,000 plus commissions and fees on April 19th.

You might be wondering why John purchased $6.00 puts when his goal is to lock in a price of $5.60.  The reason for this is that you have to find an option that will equal the price you are looking to receive after the cost of purchasing the option.  With his goal being locking in $5.60 per bushel, he knows that by purchasing the $6.00 calls for 40 cents each he will be able to lock in a price of $5.60.

October is now here and the December corn futures price is $5.50.  The $6.00 puts are now worth $3,500.  Due to the time value left in the puts ($1,000), John decides to liquidate them instead of exercising them into futures positions (refer to the article linked above to refresh your memory on time value and intrinsic value).

$3,500  (Gain from liquidating option)
-2,000   (Amount paid per option)
$1,500   gain per option
x      3    options
$4,500   gain from hedging with options
-1,500   (10 cent loss per bushel in cash grain times 15,000 bushels)
$3,000  total gain

Due to the option still having time value left, John was actually able to receive $5.70 per bushel for his corn (3000/3 contract = $1000 gain per contract / $50 per cent = 20 cents + cash price of $5.50 = $5.70 per bushel).  This is 10 cents higher than he initially was looking to receive for his corn.

Summary

Hedging with options is a great way to provide a margin free from of risk management.  Simply figure out the price you would like to receive for what you produce, and find an option that helps you lock in that price after the price of the option is paid.

Filed Under: Tips & Strategies

About Drew Wilkins

Drew received his B.S. in Agricultural Business from the University of Arkansas. Growing up in Arkansas, he was always familiar with agriculture. However, it was a Futures and Options class in college that sparked his interest in making a career out of the markets. “Learning more about the overall marketplace was fascinating. From hedging to speculating, the futures markets offer a risk management and investment avenue not found anywhere else.”

Since joining Daniels Trading, Drew has helped his many clients navigate the markets. He prides himself in being diverse in his execution abilities. Whether you are looking to enter a multi-leg option spread or enter a market order online, he can help you get it done. Drew knows that not every client is the same. One of the aspects he enjoys most is working with new clients and helping them formulate a plan on how they want to approach the market.

When out of the office, Drew enjoys playing golf, flag football and cheering for the Razorbacks.

Risk Disclosure

WHEN INVESTING IN THE PURCHASING OF OPTIONS, YOU MAY LOSE ALL OF THE MONEY YOU INVESTED.

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

Subscribe To The Blog

Footer

Site Navigation

  • Frequently Asked Questions
  • About Us
  • Customer Reviews
  • Contact Us
  • Futures Blog
  • Open a Futures Trading Account
  • Media Resources
  • Fund Your Account
  • Legal Notices

Contact Us

StoneX Financial Inc.
Daniels Trading Division
230 South LaSalle Suite 10-500
Chicago, IL 60604
+1.312.706.7600 Local / Int'l
+1.800.800.3840 Toll-Free
+1.312.706.7605 Fax

Connect with Us

Trustpilot
Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

  • Risk Disclosure
  • Privacy Policy
  • California Residents Privacy Notice
  • Terms of Use
  • Back to top