Let me paint you a picture: harvest is winding down and you’re pulling the last of the crop out of the field. The price you could get at the elevator is hovering right around that breakeven level, which is good, but you’re aiming to bring in a profit for the year. You have storage bins on farm, so you know you have a place to put the grain if you don’t sell it. After this turbulent year of prices, you’re going back and forth to decide whether you should sell and breakeven, or store the crop and hold off sales in hopes of a potential winter rally like we saw in February 2018.
What should you do? Sell and run the risk of staring down seller’s remorse if we catch a winter rally? Or store it and risk prices potentially breaking below your breakeven levels? How about an option that allows you to protect that price while still holding out for a potential rally.
Put Options Explained
If that last option appealed to you, then I’d say read on. Now, how exactly that is possible? It involves using something that you may have heard of in a passing conversation or two: a ‘put’ option. Some may be well versed in put options, and that’s great. However, I know there are plenty of people out there who have heard the term but aren’t familiar enough with put options to feel comfortable using them. If you fall in that camp, you’re definitely not alone. The fact that you’re reading this article right now is a great first step because it shows that you have the desire to learn and build your metaphorical tool bag. Basically, a put option is extremely effective in the situation I talked about in the beginning because it allows you to protect your downside while still keeping your upside completely open.
A put option allows you to set a floor so that if prices go lower, you can sleep easy knowing the put option is gaining value to help offset some of the loss on the cash bushels. At the same time, you’re still holding the physical bushels in the bin, so if we catch a winter rally like we saw in 2018 with weather issues in South America, then you can take advantage of the rally and sell the bushels at that higher price. You’re protecting your downside while leaving your upside open.
Next Steps: Protecting Your Bottom Line with Put Options
Naturally, I’m sure you’re thinking to yourself that there has to be a catch to this. There isn’t. You do have to purchase the put option, which indeed does cost money on the front end. But the question you have to ask yourself is: would you rather spend a few cents per bushel up front for peace of mind knowing you have your downside protected or would you rather risk losing an undetermined amount of money if prices fall and you don’t have that downside protection? Maybe I’m incorrect, but knowing how much these markets can move, I would think that making sure I’m protecting my bottom line would be the number one priority even if it costs me a little bit up front. But, to each their own.