Options are neglected tool in managing marketing risk

Option contracts are getting a lot of attention these days — for all the wrong reasons.

They have been massively used and abused, often to disastrous results, by the hordes of homebound, overconfident young men idled by the pandemic, who flocked to trading platforms like Robinhood to make overnight riches.

Many of them put everything they had, often from credit card cash advances and home equity loans, into buying call options to take advantage of the massive bull rally of the spring and summer.

That rally’s gone, and so is the newfound wealth of many of those amateur investors.

It’s a great example of how to use options badly.

But for farmers, options are a sadly neglected tool in marketing and risk management.

Used right, like price insurance, they can play a vital role in squeezing the most out of the volatile markets we’re likely to have for a couple of years. They can open the upside and protect against the downside with no risk, while leaving farmers with more freedom to control their marketing than many other tools allow.

There’s a cost to options, the premium, which stops most people from using them. That’s a pity because there are ways to minimize that cost.

There are also ways to make money from options without incurring much risk, as in writing call options while holding an equivalent amount of physical, unpriced crop. The physical crop covers the risk of the option being triggered, the same way a futures position is hedged by the possession of an equivalent amount of real crop.

It’s a form of “covered-call” strategy that can almost always earn a farmer a few more bucks than he would otherwise make, but few farmers will ever employ the strategy.

It’s something I chatted about recently with David Derwin of P.I. Financial, a broker who is a big fan of options for farmers.

As part of an holistic risk management and marketing strategy, options can have an important role, but they take a little more work than using futures, basis or flat price contracts at the grain elevator.

One of the biggest hurdles for farmers, I’m sure, is understanding options and the strategies they can be used in. All the concepts are pretty simple, but it takes a little while to get one’s head around them.

That’s why I’m going to start a series of features laying out various options-based strategies, relying on people like David to paint a few pictures of how options can be employed to mitigate farmers’ risk and sometimes enable them to pull a few extra bucks out of the market.

Hopefully, it’ll be a bit of “news you can use” over the winter months, before the next crop season looms and everybody’s attentions turns back from marketing grain to growing it.

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