can I lock in FPC with put option?

[Ron]

I was just looking at Kansas wheat, $4.41 for Dec/06 If the price hasnt dropped when the FPC options come out we should be able to lock in a decent price on CPS?
But if the rally is over we have no chance? If I buy a put option for Dec Kansas wheat and the price drops I should gather any difference through my put (less the premium). Then my risk is only the CWB basis?
$4.20 Dec put is .301, should lock in a price of $3.899/bu US=$4.43 Cnd, less the cwb basis approx .40/bu is 4.03 less cwb deductions is $2.84/bu. Not that good after all.
But if I have to guts to do it by going short the market (no option) I get to keep the .301 put price which would make it $3.18/bu net.
Will this work? Is $3.18 enough for CPS? What is the risk? (would I be better off using near by months rather than Dec)?
Has anybody tried this? (or something that would work better)
Thanks

[Ron]

I could just sell the Kansas market and hope the CWB price will follow the Kansas up? Lock in a FPC when I like the price and exit my short position.
Risk is cdn $ rising, CWB not reacting to rising market, running out of money for margin calls while the CWB is ignoring the rising market. Probably not my best idea. Better go outside and cool off before I phone my broker

[melvill]

A couple of comments, Ron.

1) All Dec put options (in fact, both put and call options) have a significant amount of time value in the premium because it's a long way 'till Nov when they expire.
2) At-the-money Dec puts (and calls) have the highest amount of time value in the premium of any of strike price.

So why not use more nearby options, like May (or July) as short term price insurance and "switch" to CWB Fixed Price or basis contracts once they become available. The "switch" could be done by buying the options now and then selling them in late Feb or early Mar when the CWB contracts become available.

Remember that May options expire in April so, in my opinion, July could be a better bet except that the premium will be higher because of higher time value.

Another suggestion is to buy one strike price out of the money to save on time value. Of course that reduces your coverage level, too. It's probably best to think of options as price disaster insurance rather than perfect coverage insurance for smaller movements downward.

Any other ideas?

[lakenheath]

Lee,

So if the futures market is at $4.00 today (for example). A farmer would purchase a put option at a value higher than $4.00 to reduce the premium on the option (on a July option)?

[melvill]

Sorry for the confusion. To save a little on the time value on a put, if the futures was at $4.00 you could buy a put at a strike price of, say, $3.90. A $3.90 put is $.10/bu out-of-the-money which gives $.10/bu. less coverage if the market takes a tumble.

[lakenheath]

Lee,

Does a person consider freight when using the futures market to hedge price risk. I would assume no. From what I understand you try to use a put when you think the futures grain prices are at a level you could profit at. And it's basic job is to cushion the blow of falling commodity prices you recieve for your grain that year.

[lakenheath]

Sorry if i am boring you with the ABC's of hedging. But I think this is quite new to a lot of us farmers out there.

[lakenheath]

One more question,

Using the $4.00 futures price today and assume a farmer purchases a put option out of the money at $3.90. What approximately would the option cost if you were looking to hedge 20,000 bushels of wheat.

If grain is $5.00 a bushel after harvest, obviously your option would expire and you would lose your money invested in the option, but approximately how much?

[melvill]

Phew, something other than a policy discussion on Agriville! I had to pick myself up off the floor. Okay, let's try to answer some questions.

Lakenheath, I'll try to answer one question at a time. Canadian wheat producers have (arguably) three factors contributing to wheat price risk: futures risk, exchange risk and CWB basis. A put option on US wheat futures would be one way of covering some of the possible downside to U.S. futures. Therefore, Cdn freight isn't part of that equation. Freight is part of the basis issue.

I couldn't find Minni options quote but I could find K.C. options quotes.

KC July wheat closed at US$4.37/bu.
KC July $4.40 put ask @ US$.26/bu.
KC July $4.20 put traded @ US$.29/bu.
KC July $4.20 put traded @ US$.215/bu.

A July put would be decent protection for up to early to mid May.

IF I wanted to buy puts as protection, I'd be tempted to use them for that until, say March, and then sell them to recover some of the premium. Selling them is much like when you sell your pickup, you can return to your insurance seller and get a refund of part of your premium.

KC Dec wheat closed at US$4.47 3/4 /bu.
There was very thin trade in Dec puts so I can't give you a reliable quote.

You can figure your costs for a 20,000-bushel crop from these quotes.

Puts (and calls) are price insurance, which like insurance on your pickup, is available to cover disasters not every last penny of value of damage on your pickup.

[melvill]

Melvill, you sound like you know what your talking about.

I 've wanted to learn more about puts, and calls for quite sometime now but I've always been to embarassed to ask. I know how basis and that stuff works but no clue on the puts and calls, I've been wondering the same thing. How can take advantage of this rally now, before FPO's come out in late Feb? Can you please point me in the right direction? I don't know where to start.

[MBFarmer1]

Congrats, toughgoofit!!!! You have just done something considered a sin by most farmers. Admitted you didn't know something??!! Shocking!!! IF we were all so honest things would be better. At university I took courses on the futures market and could still likely explain how it works theoretically. But if you asked me to apply that information to my on farm in a hands on, practical basis like how to set up a futures account, who to call, what does it cost, how can I use it as a tool on my farm, the silence would be deafening. I do not have a hot clue. Nada. So if there is room in the classroom for one more I would be pleased to join !!

[carebear300]

Keep this up!!!!!!!!!!! There is something starting to sink into this thick head for a change. Have learnt more here on this subject this morning then I learnt the last thirty years. Thankyou again.

[Ron]

So I can buy a july put @ 4.20, wait untill FPC becomes available, ride the rally up untill I like the FPC, lock in a price, then sell my put for the intrinsic value. This will cover me if the CWB misses the ball and I cant lock in a decent fpc before the rally ends my put will have value untill June (end of options trading?), it will be worth the difference in price plus time value which will erode untill expirey? (I rememer just enough from college to be dangerous so please correct me before it costs me real money)

[Ron]

I had earlier asked my question to Melvill, I would post it now to anyone. How do I go about finding more out about this stuff? I've asked at my local elevators they know less than me. Any help?

[melvill]

toughgoofit, are you in Alberta? If you are, my two colleagues and I put on in-depth marketing courses all the time where we teach all about this futures stuff and puts and call and strategies for using them, etc.

For a little night time reading have a look at the Alta Ag. Marketing Manual at

http://www1.agric.gov.ab.ca/$department/deptdocs.nsf/all/sis8570

We're gradually getting it updated and posted to that new page.

Want more info send me an e-mail at

lee.melvill@gov.ab.ca

and I'll see what written material I can send you.