Editor’s note: This is part 14 of a series discussing how you can use options to improve your grain marketing.
- Dan contracted 5,000 bushels of wheat at $11.00 on an HTA and bought the $9 and $10 puts for 29 cents each.
- Joe contracted 5,000 bushels of wheat at $11.00 on an HTA and bought the $10 and $11 puts for 59 cents each.
- Don didn’t sell the futures or HTA, but bought a $9 put for 29 cents and then when the future gained a dollar he bought a $10 put for 29 cents.
- Junior didn’t sell futures or HTA, but bought the $10 put for 59 cents and after the market went up a dollar, Junior bought the $11 put for 59 cents.
The chart below shows the futures price and put values on July 8 on the left and the same for July 15 on the right. September Wheat fell $1.14½. If you don’t know that the puts have increased in value, you need to go back to lesson one.
Example 1: Dan
Dan paid 29 cents a bushel for two options. That would be 10,000 bushels of options at 29 cents for a total option cost of $2,900.
On July 15, the $9.00 put was worth $6,243.75. The $10 put was worth $11,168.75. Together, these puts were worth $17,512.50.
Dan paid $2,900 for the pair, so his net winnings as of Friday’s close were $14,612.50.
Divide the put profit by the 5,000 bushels he agreed; He needs to add $2.92 to his HTA price of $11.00. That moves his HTA to $13.92 net HTA price. Not bad considering he sold his wheat for $2.85 under the contract high of $12.85 was reached on May 17th.
Yes, ladies and gentlemen, his net price for his wheat is $2.07 above the contract high. In 1990, a competing merchandiser who didn’t want to buy the puts for my customers told one of my farmer customers “that must be illegal.” No, it is not illegal to pay a price higher than the annual high if earned.
Perhaps even better, for every cent of wheat going down, Dan’s net selling price will increase by about 2 cents, since the value of the puts will increase by about 1 cent for every 1 cent fall in the futures price. Of course, the opposite is true when the wheat is moving higher. Dan could close the options by selling now and settle for $13.92, or opt for more but risk getting less.
Example 2: Joe
Joe paid 59 cents a bushel for two options. That would be 10,000 bushels of options at 59 cents for a total option cost of $5,900.
On July 15, the $10.00 put was worth $11,168.25. The $11 put was worth $16,168.25. Together, these puts were worth $27,336.50.
Joe paid $5,900 for the pair, so his net winnings as of Friday’s close were $21,436.50. Divide the put profit by the 5,000 bushels he contracted and he has $4.28 to add to his HTA price of $11.00. That puts him at an HTA net price of $15.28. Not a bad price selling his wheat at $2.85 under the contract high of $12.85.
Don and Junior: No HTA or futures contracts
Don bought the cheap puts just like Dan did, and Junior bought the expensive puts just like Joe did, but neither of them traded wheat on an HTA or forward contract. How are you?
Don’s cheap puts had the same return as Dan’s puts, $2.92 a bushel. September futures traded at $7.76¾ on Friday, making Don’s net HTA price on the day $10.69 ($7.77 futures price + $2.92 options gain).
Junior’s expensive puts had a net gain of $4.28 a bushel to take his wheat to $12.05.
After Don and Junior bought a put, they didn’t particularly care if wheat went higher or lower because either way they would increase their wheat price. If the futures went higher and stayed there, the puts would expire worthless and they would sell wheat at a price above the floor set by the puts. When wheat futures fell, the puts increased the value of his wheat.
The seasonal wheat price trend appears at the end of August. September options expire on August 26 this year. So it’s time to look for a futures price near the contract low to sell the puts. Fortunately, futures prices usually stay near the bottom for several months. It is much easier to pick a price near the low than a price near the high. That will be the topic for next week.
This is part 14 of a series. To learn more, read:
Part One: Put options add value to your cash grain sales
Part two: Secure your crops without margin calls
Part Three: Improve Your Odds of Winning with Put Options
Part Four: Put Options and No Margin Calls
Part Five: When Does a Put Option Have No Potential Value?
Part 6: Why are put options so expensive?
Part seven: Use puts to manage grain marketing risk
Part 8: What is the time value of an option?
Part 9: How to calculate the time value of an option
Part Ten: Use Puts with Hedge-to-Arrive to Increase Farm Income
Part Eleven: Sample timeline to explain how wheat works
Part 12: Put options complement futures contracts
Part Thirteen: Put Options: Understanding Premium and Delta
Wright is an Ohio-based grain marketing consultant. Contact him at (937) 605-1061 or [email protected]. Read more insights at www.wrightonthemarket.com.
No one associated with Wright on the Market is a cash grain broker or a futures market broker. All information presented is researched and believed to be true and correct, but nothing on this store is 100% accurate.
The opinions of the author are not necessarily those of Farm Futures or Farm Progress.