Like many other soybeans producers, Simpson began booking crops early in the 2009 marketing season. He booked half of his expected production at an average price of just above $9.00 before basis. His plan is to back up his booking with calls later in the season.
“At the time we did the booking, I thought I’d locked in a very good price, but a few months later when prices traded above $15.00, I wasn’t so sure. (Marketer Steve Scott) reminded me I still had one-half of my expected crop to sell”.
The next order of business for Greg was to protect the balance of his expected crop. Scott also suggested that he protect 2010 prices. At that time, Nov09 futures were trading above $13 and Greg’s local elevators were no longer offering 2009 booking contracts, not to mention 2010. Not wanting to hedge prices himself and take on the margin risk in such a wild market, Scott suggested Simpson buy puts. With market volatility running above 40 percent, put premiums were quite high — at the time, Nov09 $10 puts were trading at 50 cents.
Simpson, who was familiar with puts from past use, bought the $10 puts in order to lay in a price floor under the remaining 50 percent of his expected production. To help offset the cost of the puts, Scott suggested he consider writing a limited number of Nov09 $13 calls which were trading at $1.85 at the time. Simpson wrote one call for every three puts he bought.
“Greg understood when you write a call, you receive the premium, which in this case, more than offset the cost of the expensive puts,” says Scott. “He also knows if Nov09 futures trade above $13, the strike price of the calls, the $13 calls could be exercised and he would be obligated to assume a short futures position at $13. With expected production yet to price, selling Nov09 futures would establish a hedge to arrive contract for him, locking in $13 futures with the basis to be set later. That is a price point he would be very happy with. Since the calls represent only one-third of his anticipated production, the remaining two-thirds would continue to gain value should prices trade higher.”
As for Simpson’s 2010 production, he bought Nov09 $10 puts and wrote Nov09 $13 calls also on a 3:1 ratio to protect 100 percent of his expected production. Options for Nov10 were unavailable at the time.
“He was able to use 2009 options because Nov09 and Nov10 futures are trading in a very similar pattern,” says Scott. “If Nov09 futures trade lower, expectations are Nov10 futures will do the same.”
The 2009 puts will protect 2010 production until they expire in October 2009. “If prices have fallen (which they have), the plan is to either cash the puts in and apply the proceeds to 2010 or roll the puts to a Nov10 strike. If price trade higher and the $13 Nov09 calls were to be exercised, we would then roll the short Nov09 futures to Nov10, establishing a 2010 hedge to arrive contract.”