Selling grain for cash at harvest and buying call options may be a necessity for farmers who do not have enough bins. But using paper to replace the real thing can seem like a waste of money if positions lose most or even all of their value.
Still, the calls have paid off for corn and soybeans over the past two years, exceeding expectations by bringing in big profits, according to Farm Futures’ long-term study of storage strategies. The secret to this success is also why growers shouldn’t automatically assume the tactic will work again at harvest this fall.
Call options give the right, but not the obligation, to buy futures contracts at a predetermined strike price in exchange for a premium. This cost, paid upfront, is a headwind on profits, especially for growers who want months of exposure to take advantage of the following summer’s rallies.
Several factors affect premiums, including interest rates, the strike price of the option, the underlying futures contracts, and volatility due to the risk of large price swings. But the time until the option expires about a week before the start of futures delivery also adds significantly to the cost of this insurance. At harvest, July options, which exit the chart at the end of June of the following year, typically cost more than similar futures positions with closer delivery.
This influence is known as time value, the amount of premium that could not be recovered by exercising the option immediately.
Let’s say the July futures at harvest are $6 a bushel and the July $6 call is 45 cents. The “at-the-money” position with a strike price close to where futures are currently trading would pay nothing if exercised – it has no “intrinsic value”, as it is known in the jargon options.
Related: Put Options: Time Value vs. Intrinsic Value
Limited downside risk
But if the underlying futures contracts go up far enough fast enough, the calls can pay off big – and that’s exactly what has happened each of the past two years.
July’s parity corn calls returned $1.59 a bushel for 2022. That wasn’t as strong as the $2.16 gain seen in 2021, but it was still 10 times the average dating back to 1985 The July soybean parity call gained $2.58, a few cents higher than a year earlier, despite futures falling $2 at expiration from June contract highs.
Buy calls on 2021 crops have not yielded as much as some other strategies, such as buying futures or using storage. But the downside risk was limited to the cost of the options.
On-farm corn storage remains the most cost-effective long-term storage strategy at the sites, eight for corn and seven for soybeans, tracked by the study. Putting grain in the trash comes with its own set of risks if the market turns sour. On-farm storage of soybeans from the 1988 crop lost $1.48, or nearly 20% of the value of their crop. The 2019 corn release — en route to the COVID pandemic — generated losses of 84 cents a bushel, even more on a percentage basis.
On average, calls seem to work a little better for soybeans than for corn. While on-farm soy storage pays off 70% of the time, calls have paid off 46% of the years. On average, parity corn calls earned 14 cents, 41% of forward earnings, and made money in only 35% of the 34 years of the study.
Soybean calls also fare better on another key options metric. The average gain for soybean calls at 45 cents was exactly what is supposed to happen, at least in the short term with calls at par.
Public enemy #1 for options
These positions start with a “delta” of about 0.5. In other words, they must reflect 50% of the change in the value of their underlying futures contracts. Declining time value, public enemy No. 1 of options buyers, has not impacted trading profits as much as it has with corn.
And although spot corn storage was the most profitable strategy for this crop, it made less money than soybeans, ending up in the dark 57% of the time.
The tool with the highest batting average for either crop was the corn storage hedge, where cash inventory is protected by a futures contract sale. Profits are more consistent, but this strategy limits gains to base appreciation, regardless of the fixed price. So while cash storage brought in $2.15 for corn from the 2021 crop, storage cover brought in only 18 cents.
The soybean hedging strategy returned the same amount as corn. But on average since 1985, covering soybeans at harvest was a washout, yielding nothing. This is largely due to carry, in this case the difference between the crop delivery and the July futures.
In most years, the soybean market does not encourage carry storage because end users want harvest in the months immediately following harvest, before the pipelines fill up with production from South America. During the disruptions of the trade war with China and the pandemic, this dynamic has changed.
Corn last year offered 15 to 18 cents of carry from December to July around harvest, just over 2 cents a month and less than a quarter of the total cost for commercial hedges. Soybean carry traded as high as 38 cents in October, much higher than usual – although it still represents only around 40% of the total carry.
This year, summer markets traded at more than their usual range. The tight 2021 crop carryover projections have crop futures with only a small discount from July 2023, giving storage operators little incentive.
That could change, of course, when the combines start rolling. At-the-money options will always look expensive, regardless. We won’t know if that cost is worth it for months. But a smaller crop and a tight carryover could make paper stockpiling more attractive to growers who need to limit downside risk.
The Farm Futures study examines storage returns after costs from 1985 to 2021. This includes interest on debt incurred because grain is not sold at harvest to repay loans, as well as expenses for commissions brokerage, handling and commercial storage. No depreciation for bins or equipment is added as this varies greatly from farm to farm.
To view the full annual results of our storage study, click on the links below:
North Central Iowa
Knorr writes from Chicago, Illinois. Email him at [email protected]
The opinions of the author are not necessarily those of Farm Futures or Farm Progress.