Melvin Brees
Farm Management Specialist
University of Missouri Extension




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December 22, 2000

Commodity Options---You Probably Should Be Using Them

Agriculture commodity options were introduced in the mid-1980s. Some farmers have become comfortable using options as a part of their marketing strategies. However, many others have never used them. If you are among those who haven't used them, you're missing out on a useful price protection tool. Using options can provide price insurance, market flexibility and avoid some of the pitfalls associated with cash contracts or futures hedges. At first, options may seem complicated with confusing terminology (puts, calls, strike prices, premiums, etc.). Market advisors sometimes add to this confusion by recommending complicated marketing strategies using prices spreads along with buying and selling (writing) options.

Option strategies don't have to be complicated! Buying an option can be like buying insurance. Commodity options provide the right, but no obligation, to sell (or buy) a commodity (in the futures market) at a stated price (the option strike price). You can select a strike price that you want to protect or "insure" if prices should move against you. To purchase this right you pay a premium (cost of the option)--just like other insurance.

A put option can be used to "insure" against lower prices. A put option gives you the right to sell futures, or "put" the commodity on the market, at a specified (strike) futures price. If prices decline, after you purchase the put, you have the right to sell futures at the strike price and then you can buy them back at the lower price. You have effectively "sold high and bought cheap." The option gain (or "insurance payment") is added to your cash sale price giving you a net price near your "insured price." If prices go up--you don't collect your insurance, but you can sell the cash commodity at higher prices.

A call option can be used to "insure against missing higher prices." The call option provides the right to buy, or "call from the market," at the option strike price. If price increases, after you buy the call option, you can buy a futures contract at the strike price and sell it at the higher price (buy cheap, sell high). This can be a useful tool to avoid missing higher prices after you've forward contracted cash grain or have already delivered and sold cash grain. If prices go up, your gain on the option adds to your contracted or cash price--insuring that you get some of the gain from higher prices. If prices don't go up, you won't collect on your "insurance"--however, that probably means you made a very good cash sale!

Options can be a critical part of risk management and marketing strategies. Large crops, record use, somewhat tighter world grain supplies and uncertain weather will likely produce considerable price risk in 2001. If you're not comfortable with options take time to learn more about them. If you're not using them, you probably should be. --Melvin

**Market Outlook Conference, January 9, 2001, 7:00 p.m., Fayette Branch of Glasgow cooperative, Fayette. ***


University of Missouri ExtensionDecisive Marketing - December 22, 2000 -- Revised: April 20, 2004