writing call options

[just_wondering]

In the Dec.21st Western Producer
pg 16 Hedge row by Ed White he talks of Call options.
Does anyone have any experience with doing this Good, Bad, indiferent? It seems like a way to add value with little downside risk. But all I know of this stratagy is this artical
Please help me understand your experience
thanks
j_w

[TOM4CWB]

J-W

Writing call options is much the same as going short in the market... at a set level usually chosen above the market. Exercise of the option is an added risk to simply going short... it may occur before the futures underneath the option would wind the position up if a straight futures position were hedged.

What are others experience with writing options?

[JohnKenneth]

if you have canola in the bin, it works like a hedge - if the price goes up, you owe whoever you sold the call to some money, but that should be made up for by a higher-valued crop. andy sirski's old columns in grainews referred to it as a 'covered call' strategy although he only advocated it on stocks, not canola due to the lack of liquidity in wpg options.

[just_wondering]

Tom /john
any experience with writing why/why not?

Does the liquidity of winnipeg make it viable as a hedging stratagy?

[charliep]

I haven't written options (calls or puts) but have had some experience on the speculation/buying side. Without going into details, I have helped the options writer out - contributed money to their account. The thing that work for an options trader is time value (options decline in value overtime which works for the writer) and potentially volatility.

A way of thinking of this strategy is to consider the same as a grain pricing order.

Example. In the back of your mind, you have decided that you will sell $9/bu new crop canola ($396/tonne). Basis in your area is normally about $14/tonne so you would have to see WCE November canola futures above $410/tonne to achieve.

An alternative would be to set up a grain pricing order for $9/bu with your local grain company.

Another would be to write/sell a November 410 call. The estimated price (likely not traded) today was about $20/tonne. Won't go into the dirty details unless asked.

Trading options at Chicago Board of Trade is not a problem - lots of volume. KCBT and MGE have a little less volume. WCE can be more problematic but as a seller will not have as much trouble finding a trade as the buy side. You do need a broker who is familiar with valuing options (Black Scholes models) and is patient/willing to work to get the best value (something like fishing).

You need to understand risk and the implications a rallying market. In the example, you would be short the market if futures rallied over $410/tonne with all the pain if prices went silly higher than this level. I seem to remember tom4cwb sharing some of the pain of this in a wheat market that rallied on him. In that sense, it is no different than shorting the market at $410/tonne. You can also back the strategy up with stops/other market tools or be prepared (and have your banker prepared) for the margin calls.

[charliep]

I should note that the call options values are based on today's November futures which closed at about $381/tonne - $29/tonne below the strike price. Lots of fancy terms here but gets easier once you have worked through the process.

[TOM4CWB]

CHarlie,

One big draw back to selling calls... in your example for instance;

Being short ABOVE $410/t... may not help much if the market gets to $400/t and then drops to $330. Granted $350/t (add the $20 premium) is better than $330... investing in a Put option might be a wise decision.

[charliep]

I agree tom4cwb. It is like a GPO in that sense. The one advantage is you have put the $20/tonne in your pocket. The disadvantage if pricing is objective is that you haven't done anything.

The big thing for most farm managers is not the tool itself but rather knowing what they want to accomplish/the risk they are willing to take and from there reaching into the tool box of contracts/other tools to pick out the best one for them. This may not be the same for everyone.