What’s Your Biggest Worry When Thinking About Using Futures and Options?
Based on the number of conversations I’ve had with producers, I’d be willing to venture a guess that the answer is getting a ‘margin call’. Margin is one of the defining factors of the futures market. It allows speculators and hedgers alike to control sizeable contracts with as little as 5% of the total contract value. While it’s one of the things that attracts participants to the market, it also causes some to pause when thinking about utilizing the board of trade. When managed properly, margin can be a powerful tool to both hedgers and speculators. However, I know that some producers have been burned in the past by mismanaged margins, and as a result, have sworn off using margin for the rest of time. While I definitely wouldn’t recommend going that route, I want to make sure that producers who are a part of that camp know they can still use these tools without necessarily using margin, especially at this key time of year.
Why do I say this key time of year you might ask? Because as anyone who is involved in the grain markets know, there are some key decisions that are going to have to be made very soon. Do you sell out of the field for whatever the price is and call it a day? Do you pay to store the bushels somewhere in hopes that prices rise before the cost of storage bleeds you dry? Are you dead set on storing your bushels in your bins on farm until the prices are more agreeable? If your answer to the last question is yes, then you need to read the next blog in this series. However, if on farm storage simply isn’t an option and you need to go one of the other routes, but have sworn off using margin, then read on because there’s a better way.
Generate cash flow, avoid paying storage costs, keep your upside open, and avoid using any margin.
How is that possible you might ask? It’s actually rather simple. Step one: sell your bushels out of the field. This accomplishes the goal of generating cash flow and avoiding paying any storage costs. If that price is profitable and you want to call it a final sale, then by all means do so. But in this environment I know that might not be all too possible, so let me tell you how to accomplish those last two goals on top of that. After you make the physical sale, you turn around and buy a “call” option to re-own those bushels on paper. This leaves your upside open and allows you to do it without using margin. Now some of you may not be too familiar with how call options work, and that’s completely fine, you’re not alone, but that’s what you have me here for to explain. Call options have the potential to increase in value when the price of the underlying commodity increases. So if you produce corn and sell those bushels out of the field, you’d turn around and buy a corn call option. If the price of corn then increases, the call option has the potential to increase in value for you.
Now I’m not going to blow smoke at you and say call options are as simple as buy it and watch the money stack up for you. You have to pay up front to purchase the option, and if the price doesn’t increase or even goes down, then you could lose the money that you paid to buy the option. But what you have to remember is that if you paid to store the bushels and the price didn’t increase or went down, then you’d be losing all the money you paid for storage and you wouldn’t have generated any cash flows. On top of that, you could be getting even less on the cash side then you would selling out of the field. Re-owning your bushels with call options leaves your upside open for a potential rally, but is limited risk in that you can’t lose more than you pay up front to purchase the option.
Don’t let the current market conditions force you into make a decision you’ll later regret. If on farm storage isn’t an option, but you don’t want to sell at these prices or pay to store, then think deeply about grain re-ownership. Your upside is open, but you’re not letting storage costs push that desirable price further and further away. In this day and age, using all the tools available to you is the difference between letting the market dictate your future and taking the control into your own hands.
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