Hedging 2011 crop

[Mike M2692830]

With net profits looking very good for this upcoming growing season and the risk of forward selling too soon, I started looking ahead to cover forward sales. Dec 11 corn as an example. I use covered calls quite often. Buy at the money 5.30 call for .81 and sell 7.00 call for .38. Risk is .43 /bu for a possible return of 1.70. Almost a 4 to 1. Quite good in the covered call world. Similar situation in beans. FWIW.....MikeM

[time:thetippingpoint]

Since this is about tactics, I'll take a minute and bite.

First question, as you describe it, you are covering forward sales. This means that you are doing this on bushels for 2011 that you have already sold right?

Second question, how are you defining or measuring or what are you calling the "risk of forward selling too soon" ? The answer to this question might lead to a tweek in tactics to increase at least your odds of profit.

Also should include commissions since they will add up to a minimum of 2 cents and likely twice that if you adjust the call spread as the market moves, so risk is 45 cents.

I some thoughts but need to know the above for guidance.

[Mike M2692830]

I am talking about bushels that I will sell but also, I am using the Dec 11 contract as  hedge on bu I have sold for this past crop. No Texas hedge here as one could assume. The risk I am describing is the money one might leave on the table by selling in advance. Now, one might not call those dollars risk but it could be described as less profit providing the market is going to go higher. I did forget about the commission but .02 on 4.75 cash  corn isn't much to talk about. Considering the fundamentals as we know them right now, I thought the position pretty much spoke for itself....MikeM

[Artifice]

The energy world calls that a collar, or part of one.

If it is a hedge you need to see in terms of you have X upside to a max and Y to give some downside protection. If CZ11 goes to 380, no protection.

[dapper7]

art, i think you are a loon, either that or i dont understand a thing you post. d7

[time:thetippingpoint]

"I am talking about bushels that I will sell but also, I am using the Dec 11 contract as  hedge on bu I have sold for this past crop"  - OK but that is too complex for my simple mind. You are talking 2 different crop years comingled in a complex transaction. Impossible to defend that to the tax court I suspect. But OK, I get it.

"Considering the fundamentals as we know them right now"...my experience is that NO ONE knows the fundamentals of the present ever. We know the past not right now. The market trades and discounts future fundamentals. By definition it only moves if future perceptions change. Again, I get your point, we just don't use "known fundamentals" in any way in our hedging decisions. ie Anyone who flew in a plane over the midwest in early July knew that the USDA crop condition reports were fraudulent, but the market didn't.

Sorry, should of just let that stuff go.

As to tactics, given your objective, I'd do it a little differently, and maybe do it 1/3 in each of 3 different ways.

Way 1) Buy 480 call @ 1.03; sell 800 call @ .26.  Cost is 77 cents minus 54 cents in the money so only 22 cents + 2 com= 24 cents, and the way you defined opportunity, the gain would be $2.43 = roughly 10 to 1 opportunity.   More important than the numbers is the inverse delta benefit you gain by buying a deep in the money call, it only declines in value by less than 50% of the move. Said another way, a 4.80 call will be worth 75 cents even if corn declines to 4.80, so the real cost of the option is much lower than the implied $1.03.

I would only do this if I already had the bushels sold at 5.35 btw.

Way 2) This would be my preferred approach. Sell 650 call @ .45 and just add the 45 cents to the final sales price. The 45 cent gain is more than you are likely to gain on your spread given any one of many chaotic system outcomes. 6.50 call if exercised makes you short at 6.95.

Way 3) Sell 800 call @ .26; Buy 500 PUT @ .58; gives you a net short @ 4.66 Extremely profitable, and you can sell the cash when you want.

[Mike M2692830]

wow, I just suggested a way to hedge some forward sold 2011 crop. Wan't planning on defending it in a court of law...MikeM

[time:thetippingpoint]

Defending it? To whom. I assumed when you asked the question, you wanted a sincere thoughtful answer. Sorry I misunderstood.

I think over time, you will find, as I could prove to you mathematically, that buying deep in the money options is by far a better investment as a hedger shifting some risk that he (a proclaimed hedger) loosely defines and wants to shift. Buying an at the money call has terrible delta's.

Merely was trying to offer alternatives with some thoughts.

Artiface is right on this one btw, there is no downside protection and therefor no hedge of any kind, unless you sell the bushels. Since we are likely closer to a high than a low, this needs to be considered. I thought he was just pointing out the obvious as usual.

Good Luck.

[Mike M2692830]

Looks like a misunderstanding me...I do have the cash sales made so that is my downside risk eliminated. Right?MIkeM

[Mike M2692830]

Thanks for your other hedge moves here. My mistake in this whole post was to not explain my whole plan. This is just a start to the whole picture. I can't store much grain on farm so alot has to be delivered out of the field and I like to have those bu priced. What I can store is protected by either cash sales or some form of covered puts or your last suggestion. The only reason I normally don't use deep in the money calls is the cash outlay. Hope this helps in understanding what I look at and i appreciate your posts....MikeM