Everybody’s talking about how options contracts can be used as weapons of mass destruction after seeing swarms of Reddit-organized minnows take down some of the big sharks of Wall Street.
For farmers, it’s a good time to just think about using options in a grain hedging program, but for their traditional use as dull insurance products.
With the rally in old and new crop futures today, options might be the perfect tool for part of a farmer’s crop.
The minnows who took down the sharks by pushing up the price of GameStop were using out-of-the-money close-dated call options, which would only pay off if GameStop shares substantially rose.
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That’s what the minnows engineered, for a while, creating an epic short-squeeze and historic moon shot in shares of the ailing bricks-and-mortar video game retailer.
Usually out-of-the-money options don’t pay off because they’re too far out of the likely trading range or trends of the underlying asset. For speculators, they’re good for pegging expected outsized moves in a price. They worked especially well with GameStop because the minnows got organized with a coherent plan and an aggressive commitment to make it work.
For the minnows who executed the strategy, caused the shares to soar through short-covering and market-maker gamma-hedging and then got out, it was perfect. For those minnows who held on, the money went away and some are now broke. This wasn’t a low-risk strategy.
For hedgers, they’re good at protecting the upside potential or covering the downside risk. The grain market rally introduces real possibilities of big moves in both directions, so options can fit in well.
The more volatile the market, the higher options premiums go, so that makes them less attractive than if they are purchased pre-volatility. However, if the goal is to guard against extreme possibilities, then there should still be affordable possibilities.
New crop canola futures are sitting right now above the top of the price range of the past five years, which is around $540 per tonne. That’s a real opportunity, something many are already looking at and to which many have made some sales commitments, either through their grain companies or brokers.
But most farmers keep a lot of crop unpriced till they know they’ll have it in the bin, which can leave a lot of crop unpriced until very late into the season — and late into this rally.
Many are very bullish right now, so hanging on to unpriced crop probably doesn’t seem like a big risk. In light of the world situation, it probably isn’t. But it’s always worth considering the downside risk.
Out-of-the-money options can be used in that situation. They might never get used, but with such volatility in the markets, it’s hard to tell what’s going to happen.
So, whether it allows a farmer to price some more new crop now with the elevator and replace the upside with calls, or hang onto unpriced crop and protect the downside, options could work out.
Lots of grain company contracts allow for these functions, too.
The GameStop situation gave options trading a lot of attention. It’s a good reminder to farmers about an oft-ignored tool for times like now.
