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JimMeade
Veteran Advisor

Upside Insurance

I see Ray Jenkings mentioned the consideration of having some upside insurance in case the market, which is so beaten up and gloomy, has a rally.

 

An analyst on M to M the other day talked about selling grain and buying it back on paper.

 

One might say that if I was really confident that grains were going up, I'd just hold the grain or buy futures.  Why pay a premium for an option when that premium has to be earned back to even break even?  If there is enough hope for a rally that will pay back the premium, one would think one would have enough confidence to hold the cash or futures.

 

Buying a put is a different matter.  It's more like insurance because if bought at the right time and if seasonals come into play as they usually do, a put has a more reasonable chance of getting one's money back, I'd think.

 

It seems to me that buying a call option as upside insurance is speculation.  I don't see it as hedging or as insurance.  Calling it insurance doesn't make it insurance.

 

If it is speculation, there should be some way to calculate the cost of the option versus the chance it will pay off.  If the odds are in your favor you act and if not then you would sit aside.  Does anyone know of a way to value that?

 

Traders make a living selling options.  Producers buy options as insurance.  I don't see options as a profit center for farmers.  If anyone can point me to some references, I have a genuine desire to understand this options business better both from the producer and the speculator or trader perspective.

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3 Replies
illinifarmer
Advisor

Re: Upside Insurance

I'm not sure it's a good point let us know if you receive further info on this matter. I personally know most traders don't make a living selling options. They actually make a living on the trade commission off of customers buying and selling options. Most try to encourage their clients to buy or sell one way, however doesn't really matter to them if they win or lose on the trade. Typically they have a set rate to charge per trade. Now of course If the customer is making money it insures future business as well as more trading through said broker which obviously is more commissions.
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JimMeade
Veteran Advisor

Re: Upside Insurance

You are probably right that commodity introducing brokers make money on the commissions.  When I used the term traders I was probably not very precise.  I meant the people who work the options pits at the CBOT and speculators who sell options.

 

Here is a broker talking about using options in the kind of trading year we have now.

 

http://www.agriculture.com/markets/analysis/crops/consider-these-market-strategies-in-the-absence-of...

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hardnox
Advisor

Re: Upside Insurance

I have some modestly lower numbers in mind and really more of a "look" that would make me want to seriously consider something to the upside. I'd probably look at some sort of option strategy that wouldn't assume more than a brief and sharp short covering rally and wouldn't cost a lot.

 

IV on Dec calls is not particularly high for the time of year so I'd probably try to be long vol as much as price.

 

That said, I've done a better job of selling the upside than picking the low in grains the past few years so I'm prepared for the possibility that they once again won't conform to my tech view.

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