Put Options Lesson 12: Practical Application

Last week’s comments compared put option value changes with the price change of the underlying futures contract over a four-week period. The obvious conclusion was a futures hedge position would make or lose money faster than an option, but an option would never require a farmer to make a margin call.

We recommend the HTA or Forward contract as the primary pricing tool and the puts as a secondary marketing tool to add value to the HTA.

The week ending last, Friday (July 1^st), saw September CBOT wheat down 90½ cents. Below is the chart that lists put prices on June 24^th on the left and July 1^st on the right.

Note the price changes of the $9.00, $10.00 and $11.00 puts. The “Total Value” column is 5,000 bushels per put option times the premium (cents per bushel).

The $9.00 put increased in value almost 46¢ per bushel.

The $10.00 put increased in value 71¢ per bushel.

The $11.00 put increased in value almost 76¢.

We had recommended clients sell wheat on HTA contract and place orders to buy multiple puts at strike prices $1 higher and for the same premium as the first put. Of course, the futures price would have to rally about a dollar to get that second put bought at the cost as the first put and then and another dollar to get the third put bought at the same cost.

We suggested folks start at 29¢ for the $9.00 put or 59¢ for the $10 put. With the war in Ukraine, wheat went high enough the 29¢ guys were able to buy the $9 and $10 puts for 29¢ each. The 59¢ guys were able to buy the $10 and the $11 puts for 59¢.

To take profit on the puts, the object is to sell the puts when the futures are close to the bottom because that is when the puts are most valuable. The market spends a few days near the top and one to four months near the bottom. Therefore, it is lot easier to pick a futures price near the bottom than it is to pick a price near the top.

If one had decided to sell the puts on July 1^st, the 29¢ guys’ two puts made $1.98 net to add to their HTA price. The 59¢ guys’ two puts had a profit of $3.09 per bushel to add to their HTA price. That profit margin is simply the purchase price of the puts subtracted from the selling price of the puts and then adding the profit from both puts together.

Historically, $8.50 is a very good price for wheat and pricing 2022 wheat at $8.50 was the right thing to do in November 2021. After all, we had not seen $8.50 wheat for ten years. If $8.50 was your HTA price, you sold $4.35 below the contract high of $12.85. Ouch!

We recommended our clients buy put options to make some of the money on the way down they did not make on the way up. The low cost 29¢ puts on July 1^st could have made that $8.50 contract a $10.48 contract.

The expensive 59¢ puts on July 1^st could have made that $8.50 wheat HTA an $11.59 contract. And that was before wheat futures dropped another 61¢ the first two days this week after the 4^th of July holiday.

Think about those new crop corn and bean HTA contracts you have. You could have bought a $7.00 December corn put for 25¢. With December corn at $5.96 today, that $7.00 put is worth $1.26. Wouldn’t it be sweet to add a dollar a bushel to your 2022 corn price? Guess what: you may get another chance to buy that $7.00 put for 25¢ yet this month.