Interesting Canola Options Strategy

[charliep]

I had an interesting options strategy for canola. Before I suggest, it is important you read over and understand the following two statements (have the discipline to act on them as well).

1) If WCE canola futures prices ever goes over $380/t (or whatever your target price is), I will sell it.

2) The only way canola prices will go higher is if soybean oil rallies.

The idea is to sell (note I said sell so you are the writer of the call option) a May/July 380 call and use the money from the call to finance buying a CBOT soybean oil call for the same month (I will leave the strike price to you/your advisor). Because you have sold the canola call, you are responsible for margin money if the market rallies (increase in value of the call) and potentially could be short the market at values over $380/t (your plan anyway). If soybean oil rallies, the increased value of the CBOT bean oil call you bought would offset this to some extent.

What are other thoughts on this strategy? What are the risks?

An interesting idea I challenge everyone with is to come up with strategies and test them in this area. This will create some interesting discussion.

[crusher]

I'm not up to speed on the risk/reward for this type of strategy. I sold 2/3 of my on farm canola stocks last week on the futures rally and a narrowing of the basis. I had good yields and am happy with the gross returns. I may go as far as rebuying the canola if there is a dip, but that is the extent of it. Now I've got to get my brain in gear on marketing wheat!!

[TOM4CWB]

Charlie,

The real problem becomes, why do I trade futures and options?

If I do it from a speculative perspective then I am not farming any more but playing the futures market!!!

Now if I am hedging risk, and locking in profitable prices for my farm, now this is the type of risk management I am looking to invest in.

1996 was a real eye opener for me, and the staff at the CWB, as I sold the calls out of the money, just as you have suggested.

We ended up with almost $100,000 worth of margin calls at the end of April 1996.

I did end up with almost $30,000 profit on the transaction by September, but it was not my idea of a fun time, ask Brenda!!!

This is why doing a deferred delivery contract, and buying back Call options is a much less stressful way to control risk!!!

I may be considered being chicken by some but better a chicken than a roasted goose when the bank won't cover margin calls, then a person is really DEAD!!!

If a farmer has enough cash to pay spring expenses, plus cover large margin risk, then maybe just taking this profit is good enough???

Greedy people get slaughtered???

[charliep]

Tom4cwb

I agree with your statements. If farm managers in general took your advice in focusing on profit and using marketing as a way to contribute to it, Alberta farm income would improve significantly.

The strategies I suggest (getting beyond the mechanics) is to provide some tools to help farm managers make decisions in an uncertain environment. If they are caught like a deer in the headlight of a car and unwilling to make marketing decisions because prices might go higher, then these tools provide backup.

Perhaps to stir the pot up a bit, I look at marketing strategies before the crop goes into the bin as risk management (you don't know a lot about yield, grade, quality, etc as well as price). After the crop is in the bin, farm managers have to look at stored crop as an investment. If I was a farmer, the question in my mind would be where can I get the best return on my money (or save costs in terms of reducing interest on things like operating loans)? Storing grain in the bin or some other alternative?

The risks you talk about for some of the futures/options strategies are real and a person needs to understand this right up front. Doing a good job on using these tools takes time and discipline.

Charlie P.

[TOM4CWB]

Charlie,

Self dicipline is the number one issue in marketing grain.

And when I say this I mean the self dicipline to be a true hedger, and not to be a speculator.

This is a BIG problem, as many farmers can not seperate this difference in their minds.

I have heard statistics that over 80% of farmers who trade futures are taking speculative positions, or gambling, instead of risk managing their farm risk.

This is why pooling is a good idea for those who cannot keep these concepts straight.

Sunkist oranges are a good example of a farmer owned co-operative marketing agency.

Now, what risk do I take in hedging canola for next spring with little or no soil reserve moisture, and is it even reasonable in doing a basis contract until we get some snow on the ground????

[melvill]

tom4cwb,

I agree that self-discipline is one of the greatest personal attributes when it comes to marketing any commodity. In my work, I see it often but it is expressed as "I gotta try to get the highest price for each product because I'm losing money on half of the things I produce." That, in my mind, is speculating. Of course, since most farm managers came from a farming background, they grew up in that speculative "store the grain unpriced" environment and so they are comfortable with it. It doesn't seem foreign for threatening to them even if it should!