Put Options Lesson 7: Lock-in a Floor Price

Use Puts to Lock-in a Floor Price or to Enhance the HTA Price?

This seventh essay discussing how to use options to enhance your grain marketing was written Saturday, April 23, 2022.

When the futures market opens Sunday evening, you can spend 30 cents a bushel for the right to lock-in a HTA price for your corn at $6.40 on December futures. December corn futures settled at $7.24 yesterday.

If a corn farmer buys corn puts to lock in a floor price for his corn, does he want those puts to make him money? In such a case, he is using put options as his primary marketing tool.

A “floor price” is the lowest price a farmer will be paid for his grain. We all want to be paid more than the floor price for our grain. So, if a farmer paid 30 cents to lock in a $6.40 HTA price, he wants that price insurance policy to expire worthless, because, if it does, he will be selling his corn above the floor price.

I recently had a prospective client ask, “Do your clients with hedge accounts make money trading futures and options most years?” The truth is no, they don’t because the purpose of a hedge is to shift the risk of price change to somebody else. If a farmer buys puts in his hedge account every year to lock-in a floor price, he wants to lose money every year in the hedge account. A speculation account is where the trading profits are supposed to accumulate.

Yesterday, September wheat settled 2¢ lower at $10.73¼. Lower futures price means the puts should have increased in value. On the chart below, you can see the $10.00 September put settled at 58 and 1/8¢. That was down 1¢! The $9.00 put settled at 23½¢, up 5/8 of a cent.

Do not think put options do not work. Remember this:

On expiration day, if September wheat is at $8.60, absolutely the $9.00 put option will be worth 40 cents and the $10.00 put option will be worth $1.40.

If September wheat on expiration day is $9.42, absolutely the $9 put option will be worthless and the $10 put will be worth 58¢.

If that is not perfectly clear, ask yourself: If I had the choice to sell September wheat at $10.00 or $9.42 or $9.00, which price would I choose to sell wheat futures?

I say again, if one buys puts to lock in a floor price, he wants those puts to expire worthless.

However, if one buys puts and contracts his crop with an HTA (or forward contract), then he absolutely wants those puts to make money because his purpose was to enhance the HTA price. In such a situation, the HTA contract is his primary marketing tool and the put option is his secondary marketing tool.

He wants to sell the put options for more than he paid for them. If the put options expire worthless, the cost of the put option is subtracted from the HTA price.