Farmers Encouraged to Use Options
EDMONTON - Apr 24/14 - SNS -- Put options are a good way for farmers to lock in a minimum futures prioce while still being able to take advantage of future prices gains, says Neil Blue, market specialist, Alberta Agriculture and Rural Development, Vermilion.
"For example, with today's November canola futures price of $494 MT, the cost of buying a November $490 Put option is about $24 MT. Buying a 490 Put option at a cost of $24 MT would lock in a minimum futures price of $490 MT, or a net of $465 MT after considering the $24 premium and commission. If basis levels for October delivery are $50 MT, then that $490 put option would provide protection against a drop in the canola cash price below $415 MT, or about $9.40 per bushel, again including the premium and commission.
"An advantage of the Spring Price Endorsement (SPE) is the convenience of dealing with it through the Agriculture Financial Services Corporation (AFSC) versus the need with an option position to have your own futures account. A trade-off is that the SPE premium is non-redeemable compared to a put option, which could be sold before expiry to capture premium. Also, there is greater timing flexibility and decision choice with your own futures (options) account."
Neither the Spring Price Endorsement nor the put option includes a commitment for physical delivery, and neither alternative locks in the basis. "That situation can be an advantage, but having a delivery commitment has become a more important factor this spring due to restricted crop deliveries and carryover crop," says Blue. "Therefore, some farmers may choose to sign one of several types of contracts directly with a physical canola buyer, all of which contain a delivery commitment."
There are many alternative contract types available from various buyers. Commonly available contracts are a:
- deferred delivery contract (which locks in the cash price for a certain tonnage and delivery period)
- basis contract (which locks in just the basis for a certain tonnage and delivery period with the futures price to be locked in at a later date)
- minimum price contract (which locks in a minimum cash price for a certain tonnage and delivery period, and retains the ability to take advantage of a higher cash price if that become available)
"The potential disadvantage of a contract with a physical buyer is the delivery commitment, and the possible need in the case of a production shortfall to pay a buyout penalty relating to that shortfall," says Blue. "Before signing such a contract, consider asking the buyer how an Act of God clause could be incorporated into the delivery contract."
Currently, with a November futures price of $494 MT, and using a basis level of -$50 MT for October delivery, a deferred delivery contract would be available at a price of $444 MT, or about $10 per bushel. Alternatively, just a basis could be locked in on a delivery contract, with the futures price to be locked in later. Many buyers also offer minimum price contracts for canola. The minimum price, again using a basis of $50 MT under November futures, should be about $9.40 per bushel equivalent, similar to the minimum price in the put option example.
"The recommended approach to the canola pricing decision is to gather all the information about the various pricing alternatives, consider your costs of production and financial needs as well as your estimated crop carryover, storage capacity and potential production, and make the best decisions for your operation," adds Blue. "It may be prudent in the current crop marketing environment to use several different pricing alternatives to distribute the pricing risks of your upcoming crop."
Only active subscribers can read all of this article.
If you are a subscriber, please log into the website.
If you are not a subscriber, click here to subscribe to this edition of the STAT website and to learn more about becoming a subscriber.
