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Hedging Grain Market Risk with Options

July 1, 2019 by Daniels Trading| Ag Marketing

Options trading is one of the ways that producers and speculators can engage the grain markets. In contrast to buying or selling futures contracts in the corn market and wheat market, options provide a collection of exclusive opportunities. If you’re interested in becoming active in the grain market complex, then options are certainly worth a look.

Grain Options vs. Grain Futures

When it comes to hedging risk in the corn market and wheat market, futures and options contracts are indispensable parts of doing business. However, although each is technically classified as a derivatives product, their respective functionalities are very different. Here are a few key distinctions that make grain futures and grain options unique securities:

  • Commitment: One of the primary differences between futures and options is the degree of commitment. A futures contract binds participants to the stated terms of settlement, while options furnish the holder with a no-obligation right to buy or sell at a forthcoming point in time. This is a major consideration because financially settled options contracts preserve the individual’s liquidity.
  • Pricing: Although both grain futures and options are subject to the same pricing mechanism of the underlying asset, P&Ls are tallied very differently. For futures, profits and losses in the corn market and wheat market evolve on a tick-by-tick basis. This is also true for options, with contracts being either “in-the-money” or “out-of-the-money.” However, the impact on P&L is very different due to the pricing of the entire options chain in relation to the contract’s strike price.
  • Risk: Assuming the lack of any risk management parameters, buying or selling futures contracts outright exposes the trader to potentially unlimited financial liability. In contrast, options offer a fully quantified risk, with the only capital in harm’s way being the premium paid for the contract itself.

Perhaps the largest difference between futures and options is the degree of flexibility. While it’s certainly true that futures offer countless trading possibilities, options may be used in an even broader sense. Featuring limited up-front liabilities and cash settlement, grain options provide hedgers or speculators with opportunities simply not available in grain futures ― one of which is the straddle strategy.

Using the Straddle to Hedge Risk

If nothing else, the first half of 2019 has reinforced the importance of hedging for grain market producers. The catastrophic Midwestern flooding of March, April, and May brought widespread destruction to grain stores as well as a delay to the planting season. Production fallout was significant, leading to a spike in grain and oilseed prices.

For many farmers, buying futures contracts in the corn market or wheat market is a standard part of doing business. The long futures position protects crops against disaster and are frequently used to forego the risk of lagging spot market prices come harvest time. However, such strategies can be expensive and are not foolproof. When it comes to limiting the risks associated with the unexpected, implementing a straddle strategy is often a preferred course of action.

A straddle involves the buying of both a put and call option for the same product, at an identical strike price and expiration date. By doing this, a producer or trader enjoys two advantages especially useful in risk management:

  • Unlimited profit potential: By using a straddle, profits are realized as current market price deviates from the contract’s strike price. Theoretically, profit potential is unlimited. In the case of unforeseen disasters or events, straddles can produce extraordinary returns as market prices behave erratically.
  • Quantified risk: The only capital being risked in a straddle is the premium paid for the options contracts themselves. This is an important element of hedging, as unchecked assumed liabilities can prove costly.

Due to the flexibility of options, grain market speculators and hedgers alike frequently use straddles. They position participants to profit from rising or falling prices simultaneously, while adhering to a predetermined risk.

Although standard futures in the corn market and wheat market are an attractive way to address many of the downsides facing those two commodities, they do feature limitations not local to options. For many, the straddle and other options strategies are ideal ways of preserving hard-earned market share.

Getting Started with Options

At first, the ins and outs of options can be a bit intimidating. The concepts of buying and selling calls or puts appear abstract. Before jumping into the options markets, it’s imperative to have a firm grasp on the fundamentals.

A good way to boost your options IQ is through the online educational suite available courtesy of Daniels Trading. Featuring expert webinars, analysis, and blog content, it’s the next best thing to working side-by-side with a market professional.

Daniels Trading Ag Marketing Articles

Filed Under: Ag Marketing

About Daniels Trading

Daniels Trading is an independent futures brokerage firm located in the heart of Chicago’s financial district. Established by renowned commodity trader Andy Daniels in 1995, Daniels Trading is built on a culture of trust committed to the firm’s mission of Independence, Objectivity and Reliability.

Risk Disclosure

THIS MATERIAL IS CONVEYED AS A SOLICITATION FOR ENTERING INTO A DERIVATIVES TRANSACTION.

THIS MATERIAL HAS BEEN PREPARED BY A DANIELS TRADING BROKER WHO PROVIDES RESEARCH MARKET COMMENTARY AND TRADE RECOMMENDATIONS AS PART OF HIS OR HER SOLICITATION FOR ACCOUNTS AND SOLICITATION FOR TRADES; HOWEVER, DANIELS TRADING DOES NOT MAINTAIN A RESEARCH DEPARTMENT AS DEFINED IN CFTC RULE 1.71. DANIELS TRADING, ITS PRINCIPALS, BROKERS AND EMPLOYEES MAY TRADE IN DERIVATIVES FOR THEIR OWN ACCOUNTS OR FOR THE ACCOUNTS OF OTHERS. DUE TO VARIOUS FACTORS (SUCH AS RISK TOLERANCE, MARGIN REQUIREMENTS, TRADING OBJECTIVES, SHORT TERM VS. LONG TERM STRATEGIES, TECHNICAL VS. FUNDAMENTAL MARKET ANALYSIS, AND OTHER FACTORS) SUCH TRADING MAY RESULT IN THE INITIATION OR LIQUIDATION OF POSITIONS THAT ARE DIFFERENT FROM OR CONTRARY TO THE OPINIONS AND RECOMMENDATIONS CONTAINED THEREIN.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. THE RISK OF LOSS IN TRADING FUTURES CONTRACTS OR COMMODITY OPTIONS CAN BE SUBSTANTIAL, AND THEREFORE INVESTORS SHOULD UNDERSTAND THE RISKS INVOLVED IN TAKING LEVERAGED POSITIONS AND MUST ASSUME RESPONSIBILITY FOR THE RISKS ASSOCIATED WITH SUCH INVESTMENTS AND FOR THEIR RESULTS.

TRADE RECOMMENDATIONS AND PROFIT/LOSS CALCULATIONS MAY NOT INCLUDE COMMISSIONS AND FEES. PLEASE CONSULT YOUR BROKER FOR DETAILS BASED ON YOUR TRADING ARRANGEMENT AND COMMISSION SETUP.

YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES AND FINANCIAL RESOURCES. YOU SHOULD READ THE "RISK DISCLOSURE" WEBPAGE ACCESSED AT WWW.DANIELSTRADING.COM AT THE BOTTOM OF THE HOMEPAGE. DANIELS TRADING IS NOT AFFILIATED WITH NOR DOES IT ENDORSE ANY TRADING SYSTEM, NEWSLETTER OR OTHER SIMILAR SERVICE. DANIELS TRADING DOES NOT GUARANTEE OR VERIFY ANY PERFORMANCE CLAIMS MADE BY SUCH SYSTEMS OR SERVICE.

GLOBAL ASSET ADVISORS, LLC (“GAA”) (DBA: DANIELS TRADING, TOP THIRD AG MARKETING AND FUTURES ONLINE) IS AN INTRODUCING BROKER TO GAIN CAPITAL GROUP, LLC (GCG) A FUTURES COMMISSION MERCHANT AND RETAIL FOREIGN EXCHANGE DEALER. GAA AND GCG ARE WHOLLY OWNED SUBSIDIARIES OF STONEX GROUP INC. (NASDAQ:SNEX) THE ULTIMATE PARENT COMPANY.

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Risk Disclosure

THIS MATERIAL IS CONVEYED AS A SOLICITATION FOR ENTERING INTO A DERIVATIVES TRANSACTION.

THIS MATERIAL HAS BEEN PREPARED BY A DANIELS TRADING BROKER WHO PROVIDES RESEARCH MARKET COMMENTARY AND TRADE RECOMMENDATIONS AS PART OF HIS OR HER SOLICITATION FOR ACCOUNTS AND SOLICITATION FOR TRADES; HOWEVER, DANIELS TRADING DOES NOT MAINTAIN A RESEARCH DEPARTMENT AS DEFINED IN CFTC RULE 1.71. DANIELS TRADING, ITS PRINCIPALS, BROKERS AND EMPLOYEES MAY TRADE IN DERIVATIVES FOR THEIR OWN ACCOUNTS OR FOR THE ACCOUNTS OF OTHERS. DUE TO VARIOUS FACTORS (SUCH AS RISK TOLERANCE, MARGIN REQUIREMENTS, TRADING OBJECTIVES, SHORT TERM VS. LONG TERM STRATEGIES, TECHNICAL VS. FUNDAMENTAL MARKET ANALYSIS, AND OTHER FACTORS) SUCH TRADING MAY RESULT IN THE INITIATION OR LIQUIDATION OF POSITIONS THAT ARE DIFFERENT FROM OR CONTRARY TO THE OPINIONS AND RECOMMENDATIONS CONTAINED THEREIN.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. THE RISK OF LOSS IN TRADING FUTURES CONTRACTS OR COMMODITY OPTIONS CAN BE SUBSTANTIAL, AND THEREFORE INVESTORS SHOULD UNDERSTAND THE RISKS INVOLVED IN TAKING LEVERAGED POSITIONS AND MUST ASSUME RESPONSIBILITY FOR THE RISKS ASSOCIATED WITH SUCH INVESTMENTS AND FOR THEIR RESULTS.

TRADE RECOMMENDATIONS AND PROFIT/LOSS CALCULATIONS MAY NOT INCLUDE COMMISSIONS AND FEES. PLEASE CONSULT YOUR BROKER FOR DETAILS BASED ON YOUR TRADING ARRANGEMENT AND COMMISSION SETUP.

YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES AND FINANCIAL RESOURCES. YOU SHOULD READ THE "RISK DISCLOSURE" WEBPAGE ACCESSED AT WWW.DANIELSTRADING.COM AT THE BOTTOM OF THE HOMEPAGE. DANIELS TRADING IS NOT AFFILIATED WITH NOR DOES IT ENDORSE ANY TRADING SYSTEM, NEWSLETTER OR OTHER SIMILAR SERVICE. DANIELS TRADING DOES NOT GUARANTEE OR VERIFY ANY PERFORMANCE CLAIMS MADE BY SUCH SYSTEMS OR SERVICE.

GLOBAL ASSET ADVISORS, LLC (“GAA”) (DBA: DANIELS TRADING, TOP THIRD AG MARKETING AND FUTURES ONLINE) IS AN INTRODUCING BROKER TO GAIN CAPITAL GROUP, LLC (GCG) A FUTURES COMMISSION MERCHANT AND RETAIL FOREIGN EXCHANGE DEALER. GAA AND GCG ARE WHOLLY OWNED SUBSIDIARIES OF STONEX GROUP INC. (NASDAQ:SNEX) THE ULTIMATE PARENT COMPANY.

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