Establishing Floors

Posted on: May 28, 2020 | General Info, MAC News

By: Mackenzy Blair

This year we have witnessed commodity prices plummet due to COVID-19 related issues. With this extremely volatile market one way we can reduce risk is by setting floors. A couple different ways we can establish a floor is with a minimum price contract or we can cheapen up that cost with a min/max contract that utilizes both a floor and ceiling.

An example of both of these contracts is as follows using December 2020 corn:

  • For the minimum price contract we would sell Dec 20 corn futures at the market which is 3.35 as I write this; we would also buy a call option to attach to this contract. An “in the money” call option would cost us 23 cents and MAC would charge a 2 cent fee on top of this. The “in the money” option has a .50 Delta so what this means is that a 2 cent rise in futures would be about a 1 cent gain in the option premium. If the market continues to go higher the option would be further “into the money” and the gain on the option premium would be greater. The minimum price on this contract would be 3.10 Dec 20 futures (3.35 hedge – 25 cents total for the option) but would allow for upside potential with the call option if the market goes higher.
  • A min/max option strategy uses both a put and call option. For this strategy we would buy an in the money put for 18 cents and sell an upside call option wherever we choose to set a ceiling. I am going to use a 3.70 call at 8 cents as an example. So if we buy the put for 18 cents and sell a call for 8 cents the cost is 10 cents plus the 2 cent fee MAC charges for a total of 12 cents to the producer. This strategy cheapens up the overall cost by limiting the upside potential of the contract. We can then set targets within this 3.30-3.70 zone to sell futures and lift the options.

Both of these contracts utilize options in order to establish a floor to reduce the risk of corn prices going any lower, which is very hard to predict given the 3.3 billion bushel US carry out the USDA is forecasting for 2021.

For more information or to put either of these plans in place, contact your MAC Merchant.