5.
Contract Seasonality
The Importance of Incorporating Contract
Seasonal Pricing into a Marketing Plan
Presented By:
Dr. Steve Amosson
Regents Fellow
Professor and Extension Economist
Seasonal Price Patterns

C hS
Cash
Seasonals
l
–
Supply and demand based


–

Most modify production plans to take advantage
Contract Seasonals
–
–
–

Cash – Weaning, grazing
Crops - Harvest
Eventually tied to cash market
Tied to events that may affect supply and demand
Expands marketing opportunities
Seasonal Price Patterns
–
–
Outputs
Inputs
Agricultural Marketing
Breaking it Down

Fundamental Analysis

T h i lA
Technical
Analysis
l i

Price Seasonality of Market

Cycles,
y
, Syndromes
y
or Anomalyy
Definitions by Steve

Seasonality
–

Price variation caused by market uncertainty
associated with “normal”
normal physiological or
fundamental effects such as planting, planting
intentions, tasseling, supply and demand conditions,
and
dh
holidays.
lid
Syndrome or Anomaly
–
Price
P
i variation
i ti caused
db
by market
k t uncertainty
t i t
associated with an “unusual” event such as a short
p BSE, etc.
crop,
Percent o
P
of Averag
ge
Seasonal Index for December Corn Futures
1991 - 2005
108
106
104
102
100
98
96
94
92
90
88
J
J A S O N D J F M A M J J A S O N D
Dollarrs/Bu.
CBOT Corn December Futures Average Settlement Price
Price,
1991 – 2005, (excluding 1993 and 1995)
2.70
2.65
2 60
2.60
2.55
2.50
2 45
2.45
2.40
2.35
2.30
.30
2.25
2.20
J
J A S O N D J
F M A M J
J
A S O N D
Seasonal Cash Price Index for U
U.S.
S Sorghum
September 1995 – August 2005
P ercent oof Averaage
110
105
100
95
90
S
O
N
D
J
F
5-Year
M
A
10-Year
M
J
J
A
Moore Research Center - Seasonal Price Index

Calculate range over contract life
–

$4.00
Contract high
$6.00
Range
$2 00
$2.00
Example: Price on specific day $4.40, then the index is:
(4.40-4.00)/2=.40/2.00=.20
(4.40
4.00)/2 .40/2.00 .20
Average daily indices over years
–

Contract low
Determine daily index (0-1)
–

Example:
Example: Day 1
Year 1 = .20 Year 2 = .25 Year 3 = .15
Then, the day
y 1 average
g =
.20+.25+.15/3=.20
*NOTE: Most indices will range from .35 to .65
Expand range to fit 0–1 scale
–
Example: If .65 was the highest daily average index value, then it
b
becomes
1
1. If .30
30 was the
th llowestt iindex
d value,
l
th
then it b
becomes 0
0.
Corn
Biofuels have dramatically
changed
h
d th
the llevell b
butt nott
seasonality since 2005
Corn
Corrn
Natural Gas
N
Natural
lG
Gas
Natural Gas
Natural Gas
Two Sections Irrigated Corn

Natural Gas Use
–

1040 acres x 22 ACIN = 22,880 MCF
Corn Production
–
1040 acres x 210 bu = 218,400 bu
• What if all the NG is contracted and half
the grain is sold based on seasonals?
Harvest vs. ½ Seasonal Sales
+
Contracting all NG
Increase in
Returns ($)
NG 22
NG:
22,880
880 M
Mcff X $2
$2.00/Mcf
00/M f =
$45 760
$45,760
Corn: 218,400 X .5 X .25/bu =
$27,300
Total
$73,060
Potential Advantage of
Seasonal Pricing Per Acre
Reduced NG Cost
$44.00
Income – ½ Harvest and ½ Seasonal
$26.25
$ Change Per Acre
+ $70.25
Price Seasonality
Think About It


Corn and natural gas contracts exhibit distinct price
seasonality patterns.
The advent of biofuels production has distorted
somewhat but not eliminated seasonality patterns

Always remember patterns are averages and will not
occur every year!

You need to track prices to see if seasonal patterns
are occurring as well as factor in current
fundamentals in incorporating seasonal pricing.
Price Seasonality
Closing Comments


Virtually every commodity is subject to cash and
futures contract price seasonality.
Cash seasonal variation is generally 3%
3%-10%
10%
depending on the commodity.

Futures seasonal price variation is often double cash
volatility.

Understanding the “events” can magnify seasonal
pricing opportunities.

Incorporating seasonal pricing into a marketing plan is
not “Rocket
Rocket Science”
Science and can add 3 - 5% to a
producer’s gross and ??? to his net income.
Educational programs of Texas AgriLife Extension Service
are open to all people without regard to race
race, color
color, sex
sex,
disability, religion, age or national origin.
6.
Technical Analysis
Futures Markets—Technical Analysis Continued
J
January
20 2010
20,
Mark Welch
Grain Marketing
g
Economist
Texas AgriLife
Extension Service
Moving Averages
• Used to monitor market trends
• A useful complement to the price chart
• For example, a 3-day moving average is the
average of the last 3 daily closing prices. A
10-day is the average of the last 10 closes
• Moving average combinations are often used
to identify trends with the shorter moving
average leading the longer average. When
the market turns, the shorter average turns
more quickly
i kl and
d crosses th
the llonger and
d
slower average. This crossover action
generates buy and sell signals.
Moving Averages
800
Sell when 4-day
crosses under 9-day
9 day
750
700
650
600
550
500
Buy when 4-day
crosses over 9-day
450
400
350
1
7
13
19
25
31
37
43
49
55
61
67
73
79
85
91
97
103
109
115
121
127
133
139
145
151
157
163
169
175
181
187
193
199
205
211
217
223
229
235
300
Close
4-day MA
9-day MA
Strengths and Weaknesses of using
M i Averages
Moving
A
Strengths
• Means to objectively
identifyy trends; work best
in major, sustained price
trends
• Never without a position
in the market in the event
of a major price move
• Adds discipline to
marketing (removes
emotion)
Weaknesses
• Do not work well in
ppy markets ((the
choppy
trader is whipsawed)
• Lags price action so that
market positions are
taken after the major
move may be over; large
percentage of profit may
be lost
Modified Moving Averages
• Experiment with different lengths of
averages (these vary with commodity)
or add another average for
confirmation
• Add a penetration rule: the trade signal
is only accepted if the market moves a
specified
p
minimum amount beyond
y
a
given reference level (amount or
percentage)
Modified Moving Average:
Moving average difference must be at least 1% of price or signal is
ignored
Long
Short
Long
390
370
350
330
310
290
270
250
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 67 69 71 73
Close
4-day MA
9-day MA
Retracements
• Markets appear to have a natural
tendency to partially retrace prior
price swings
• Expect price support (resistance)
around these retracement levels
• Common expected retracements
occur at 38.2%, 50%, and 61.8%
of the recent high or low
Retracements
1200
High
1. Take the distance from a major
low to major high.
2 M
2.
Multiply
li l b
by 38
38.2%,
2% 50%,
0% and
d
61.8%.
3. Subtract these results from the
high to find resistance
1135
1100
61.8% = 1020
1000
50.0% = 985
38.2% = 950
900
Low 835
800
1. Take the distance from a major
j
high to major low.
2. Multiply by 38.2%, 50%, and
61.8%.
3. Add these results to the low to
find resistance
700
600
500
High
g
692
50%
38.2% = 626
= 606
61.8% = 586
Low 520
301
291
281
271
261
251
241
231
221
211
201
191
181
171
161
151
141
131
121
111
101
91
81
71
61
51
41
31
21
11
1
400
Retracements
High = 90.31
Low = 80.25
Retracements
High = 90.31
38.2% = 86.47
50% = 85.28
61 8% = 84
61.8%
84.09
09
Low = 80.25
Parabolics
• A stop and reverse system (SAR)
that is always in the market, either
long or short
• The SAR point is the price when
touched that triggers closing a
short position and going long or
closing a long position and going
short
Parabolics
• Initial stops are automatically
placed at the last extreme high or
low
• Stops follow the market up or
down using an acceleration factor
factor,
default is .02
• The basic principle is that the
longer you are in a move, the
more likely it is that it is over
Parabolics
• If a price is in an uptrend, the SAR
moves below
b l
th
the price
i and
d moves
upwards towards it at an
i
increasing
i pace. IIn a d
downtrend,
t d
the SAR is above the price moves
d
downwards
d iin th
the same ffashion
hi
• The SAR is calculated in advance
of the next day’s trade so a SAR
price trigger is in place ahead of
trading
July Kansas City Wheat and
Parabolic Stop and Reverse Prices
640
620
600
580
560
540
520
500
S and R = 593¼ (sell)
Low = 593
Parabolics
• Initial SAR = high or low extreme
price
i off last
l t trend
t d
• SAR tomorrow = [Extreme price of
current trend (high or low) minus
the SAR today] times .02
• Acceleration factor increases in
p to max of
increments of 0.02 ((up
0.20) each time a new extreme
point is recorded
p
July Kansas City Wheat and
Parabolic Stop and Reverse Prices
640
620
600
580
560
540
S and R = 595¾ (sell)
Low = 593
.02 .04 .06 .08 .08 .08 .08 .10 .12 .14 .14 .14 .16
520
500
.02 .04 .06
Parabolics
Trends
• Moving averages and parabolics work
b t iin major
best
j ttrends
d with
ith llong
sustained price moves
• In
I sideways
id
or ttrading
di range markets,
k t
they generate many false signals.
Markets often move far enough to
trigger a buy or sell signal then quickly
reverse—you
y get
g whipsawed
p
Oscillators
• A class of technical indicators the measure
market momentum—the rate at which prices
are changing
• Measures imbalance in the market, conditions
referred to as ‘overbought’ or oversold’
• Based on 2 basic principles
– Users believe a price rise or price decline can
become overextended if it gains too much velocity
(moves too far too fast)
– A price trend can disintegrate due to a loss of
momentum; everyone who wants to trade the trend
has done so
Oscillators—Relative Strength
I d (RSI)
Index
• RSI = weighted
i ht d average off d
daily
il price
i iincreases d
during
i
past 14 days ÷ weighted average of price changes up and
down during
gp
past 14 days
y
• Most charting services include the option of adding RSI to
any commodity chart
• Range is 0 to 100; levels of 30 and 70 are often used as
thresholds to identify overbought and oversold conditions
– At 70,, the market is moving
g to a level where everyone
y
who wants to
buy the market is in--overbought
– At 30, the pool of sellers is exhausted--oversold
Calculating RSI
1. Record last 14 day to day price
changes
2. Sum the absolute value of the
negative and positive changes
and divide each sum by 14 to
create a down average (D) and
an up average (U)
3. % RSI = (U)/(U
(U)/(U+D)
D) ×100
100
RSI
RSI is best used in conjunction with other technical indicators rather than just going
short every time RSI is overbought or going long every time RSI is oversold
oversold.
Watch for divergence between price trends and RSI trends.
Oscillators Stochastics
Oscillators--Stochastics
• A momentum indicator that shows the
location of the current close relative to
the high/low range over a set number
of trading days.
• Closing levels that are consistently
near the top of the range indicate
accumulation ((buying
y gp
pressure)) and
closing levels consistently near the
bottom of the range indicate distribution
(selling pressure)
Stochastic Calculations
•14 is a common number of days
to use for this calculation.
Periods from 5 to 20 are not
uncommon.
•Since %K is a percentage or
ratio it will
ratio,
ill fall bet
between
een 0 and
100.
•%D is a simple
p moving
g average
g
of %K plotted alongside %K and
acts as a trigger line as before.
•Values above 80 are considered
overbought and below 20 is
oversold.
The close of 115.38 is near the midpoint of the recent range (57th percentile)
Fast, Slow, and Full Stochastics
•
•
•
The previous example calculated a ‘fast’ stochastic:
direct calculation of %K and 3-day moving average of
%K ffor %D
%D.
(14,3) Fast Stochastic
Slow Stochastic uses a 3-day MA of %K (same as %D
in the fast version) for %K and %D is a 3-day moving
average of that.
(14,3) Slow Stochastic
Full Stochastic is more flexible; it allows for a different
moving average to be applied to the initial %K
calculation as well as to the %D calculation. For
example, if you used a 14-day trading range, a 3-day
moving average of %K for %K slow and a 2-day
moving average of the %K moving average to figure
%D it would
%D,
ld be
b a (14,3,2)
(14 3 2) full
f ll stochastic.
t h ti
(14,1,3) Full = (14,3) Fast
Slow Stochastic (14,3,3)
14 day trading range, %K slow = 3-day moving average of %K raw, %D = 3-day moving average of %K slow.
Watch for divergence,
divergence not just lines crossing in critical areas
areas. Some believe best
signals are when the oscillator moves from overbought back below 80 and from
oversold back above 20.
Conclusion
• Technical analysis
y
is keyy to the correct timing
g
of buy and sell decisions
• Technical dimensions do not dominate
f d
fundamentals.
t l No
N sustained
t i d ttechnical
h i l pattern
tt
will develop that is contrary to underlying
supply demand balance
• Ex post observation makes it all look easy
• Failed chart signals are perhaps the most
i
important
t t chart
h t signals
i
l
• They’re ‘futures’ markets, not ‘past’ markets
F
I
N
E
P
R
I
N
T
There is a substantial risk
off loss
l
i ffutures
in
t
and
d
options trading. Such
losses mayy exceed yyour
initial investment.
Past performance is not
necessarily an indicator of
future results.
Futures Markets—Technical Analysis
January 20, 2010
Mark Welch—Grain Marketing Economist, Texas AgriLife Extension Service
In Both Natural Gas and Grains,
Weather Is Off Traders' Screens
Thursday June 25,
Thursday,
25 2009
"The corn and soybeans markets typically are all about weather, but
weather has taken a back seat to the demand in China and
elsewhere," said Charlie Notis, a founder of Freese-Notis Weather, a
forecasting service.
…so-called market signals, such as investment funds' buying and
implied volatility, are having a larger impact. Analysts at Société
Générale give a 40% weighting to market signals, with the
remaining 60% driven by fundamentals, including weather. In early
2008, market signals were given a 15% weighting.”
Technical Analysis
• …is the study of historical prices,
usually in chart form, in order to
predict future price behavior.
• Psychology > Economics
• Technical analysis is an important
and complimentary approach to
fundamental analysis in the study
of market behavior
Technical Analysis
• It is the fundamental approach that
establishes the probable direction
of price trends and the general
price range with which the markets
are expected to trade.
• It is the technical dimension that
guides the timing of pricing
decisions within that range.
Price Information
DAY
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
OPEN
HIGH
543.5
537
509 25
509.25
507.5
469
465.5
488
484.75
455
474
466.25
442 25
442.25
443.5
458
478
465.25
439.75
450.75
433
444
460 75
460.75
479.5
468.5
543.5
LOW
553.75
541
522
507.5
480
480.75
496.5
484.75
476.75
485
470.5
445 25
445.25
464
478
485
467.25
455.5
460.75
444
467.5
481
492
469
553.75
CLOSE
536
507.5
508 75
508.75
481
463.5
456
476.25
460.5
452.75
466
440.5
422
442.5
458
463.75
436
434
427
420.5
443.75
457
460
454.5
536
537
509.5
511
481
465.5
477
490.5
460.5
466.5
467
444.5
437 5
437.5
458
476.5
465
439
446.25
427.75
443.25
451
480 25
480.25
469.5
460.5
537
Price Charts
Charts—the
the Bar Chart
580
560
High
540
Close
520
500
Low
480
460
440
420
400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
Price Charts
Charts—Close
Close Only
560
540
520
500
480
460
440
420
400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
Price Charts
Charts--Candlestick
Candlestick
580
560
High
540
Open
Close
520
500
Low
480
460
440
Close
Open
420
400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
Bar Chart—Open,
Chart Open, High, Low, Close
Close Only
Candlestick
Charts can be created for
multiple
lti l time
ti
frames
f
•
•
•
•
•
Yearly
y
Monthly
Weekly
Daily
Intraday
– Hourly
– 30 minute
– 15 minute
– 5 minute
Monthly
Daily
Weekly
Intraday—30 min
Trend Lines
• The single most important tool in
technical analysis
• Connect two or more lows in an
uptrending market; two or more highs
in a downtrend (preferably 10 or more
days apart and not too steep)
• Close below (above) the trendline
signals a change in price direction;
estimated reliability ≈ 70 to 80%
Trend Lines
490
470
450
430
410
390
370
3 0
350
1
3
5
7
9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 67 69 71 73
Support and Resistance Planes
• A
As the
th market
k t rallies
lli b
back
k ttoward
d th
the existing
i ti
contract high (or falls to its low), it will take a
significant
g
change
g in consensus of the
underlying supply balance to generate new
contract highs (lows)
• Support—a
Support a price where the market found
enough buying interest to turn prices higher
• Resistance—a p
price where the market found
enough sellers to cause the market to decline
• You can also run out of sellers (support) or
b
buyers
((resistance)
i t
)
Support and Resistance Planes
490
470
450
430
410
390
370
3 0
350
1
3
5
7
9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 67 69 71 73
9/4/2007
9/10/2007
9/14/2007
9/20/2007
9/26/2007
10/2/2007
10/8/2007
10/12/2007
10/18/2007
10/24/2007
10/30/2007
11/5/2007
11/9/2007
11/15/2007
11/21/2007
11/28/2007
12/4/2007
12/10/2007
12/14/2007
12/20/2007
12/27/2007
1/3/2008
1/9/2008
1/15/2008
1/22/2008
1/28/2008
2/1/2008
2/7/2008
2/13/2008
2/20/2008
2/26/2008
3/3/2008
3/7/2008
3/13/2008
3/19/2008
3/26/2008
4/1/2008
4/7/2008
4/11/2008
4/17/2008
4/23/2008
4/29/2008
5/5/2008
5/9/2008
5/15/2008
5/21/2008
5/28/2008
6/3/2008
6/9/2008
6/13/2008
6/19/2008
6/25/2008
Double Tops, Bottoms
1400
KC Wheat July 2008
1300
1200
1100
1000
900
800
700
600
500
400
380
Head and Shoulders
KC Wheat July 2005
360
340
320
300
280
260
The first price rally forms a ‘shoulder’ then the ‘head’ is formed as the price surges to new highs.
The second ‘shoulder’ is formed on a rally back toward the contract highs, but the rally fails—
often at about the same level as the price observed in the forming of the first ‘shoulder’.
The topping action is completed when the price closes below the ‘neckline’, a line formed by
connecting the lows during the price dips on each side of the head formation
240
220
The projected price move from the point of penetration of the ‘neckline’
neckline is the distance from the
top of the ‘head’ to the neckline. The price objective is reached or exceeded in 60 to 70% of the
cases.
20040901
20040908
20040914
20040920
20040924
20040930
20041006
20041012
20041018
20041022
20041028
20041103
20041109
20041115
20041119
20041126
20041202
20041208
20041214
20041220
20041227
20050103
20050107
20050113
20050120
20050126
20050201
20050208
20050214
20050218
20050225
20050303
20050309
20050315
20050321
20050328
20050401
20050407
20050413
20050419
20050425
20050429
20050505
20050511
20050517
20050523
20050527
20050603
20050609
20050615
20050621
20050627
20050701
20050708
20050714
200
5/31/2009
5/28/2009
5/25/2009
5/22/2009
5/19/2009
5/16/2009
5/13/2009
5/10/2009
5/7/2009
5/4/2009
5/1/2009
4/28/2009
4/25/2009
4/22/2009
4/17/2009
4/14/2009
4/8/2009
4/3/2009
3/31/2009
3/26/2009
3/23/2009
3/18/2009
3/13/2009
3/10/2009
3/5/2009
3/2/2009
2/25/2009
2/20/2009
2/17/2009
2/11/2009
2/6/2009
2/3/2009
1/29/2009
1/26/2009
1/21/2009
1/15/2009
1/12/2009
1/7/2009
1/2/2009
1100
Head and Shoulders Bottom
1050
November 2009 Soybeans
1000
950
900
850
800
750
700
360
340
320
20060801
20060803
20060807
20060809
20060811
20060815
20060817
20060821
20060823
20060825
20060829
20060831
20060905
20060907
20060911
20060913
20060915
20060919
20060921
20060925
20060927
20060929
20061003
20061005
20061009
20061011
20061013
20061017
20061019
20061023
20061025
20061027
20061031
20061102
20061106
20061108
20061110
20061114
20061116
20061120
20061122
20061127
20061129
20061201
20061205
20061207
20061211
20061213
Key Reversal
380
Must be an “outside day” (higher
high
g and lower low),
) and then
show a lower close (high).
High volume confirms the signal.
300
280
260
240
220
1/5/200
09
1/7/200
09
1/9/200
09
1/13/200
09
1/15/200
09
1/20/200
09
1/22/200
09
1/26/200
09
1/28/200
09
1/30/200
09
2/3/200
09
2/5/200
09
2/9/200
09
2/11/200
09
2/13/200
09
2/18/200
09
2/20/200
09
2/24/200
09
2/26/200
09
3/2/200
09
3/4/200
09
3/6/200
09
3/10/200
09
3/12/200
09
3/16/200
09
3/18/200
09
3/20/200
09
3/24/200
09
3/26/200
09
3/30/200
09
4/1/200
09
4/3/200
09
4/7/200
09
4/9/200
09
4/14/200
09
4/16/200
09
4/20/200
09
4/22/200
09
4/24/200
09
4/26/200
09
4/28/200
09
4/30/200
09
750
Hook Reversal
700
Similar to the key reversal but the new low or high prices do not occur on an
“outside day”. Prices push to new highs (lows) but close lower (higher).
More common than key reversals and generally less reliable.
650
600
550
500
Island Reversal
490
The key to island reversals are the gaps. In the case of an island
reversal top, the market is trying to go up so fast it does not trade
over a range of prices
prices. The market then trades in this new
territory for a few days then records a new price gap down as
prices falter. The rush to higher prices could not be sustained.
470
450
430
410
390
370
3 0
350
1
3
5
7
9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 67 69 71 73
400
80
90
100
110
120
130
140
150
160
170
180
190
200
210
220
230
240
250
260
270
280
290
300
310
320
330
340
350
360
370
380
390
400
410
420
430
440
450
460
470
480
490
500
510
520
530
540
550
560
570
Consolidation Patterns
(
(resting
ti places)
l
)
1200
1100
1000
900
Bear Flag
800
Bull Flag
700
Triangles
600
500
Channels
Gaps
490
470
There is a strong
g tendency
y for the market to fill g
gaps.
p
450
430
410
390
370
350
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61
1
4
7
10
0
13
3
16
6
19
9
22
2
25
5
28
8
31
1
34
4
37
7
40
0
43
3
46
6
49
9
52
2
55
5
58
8
61
1
64
4
67
7
70
0
73
3
76
6
79
9
82
2
85
5
88
8
91
1
94
4
97
7
100
0
103
3
106
6
109
9
112
2
115
5
118
8
121
1
124
4
127
7
130
0
133
3
136
6
139
9
142
2
145
5
148
8
151
1
154
4
157
7
850
Gaps not filled within a few
d
days
(5-10
(5 10 d
days))
3. Exhaustion Gap
750
650
2. Measuring Gap
550
1. Breakaway Gap
450
350
250
Conclusion
• Ex post (after the fact) observation
makes it all look easy
• If it was as simple as having a
degree in economics or knowing
the implication of every known
chart formation, there would be a
lot more millionaire traders out
there.
F
I
N
E
P
R
I
N
T
There is a substantial risk
off loss
l
i ffutures
in
t
and
d
options trading. Such
losses mayy exceed yyour
initial investment.
Past performance is not
necessarily an indicator of
future results.
7.
Marketing Tools
& Strategies
Marketing Tools and
Strategies
Marketing Plan Seminar
Mark Welch—Grain Marketing Economist
January 20, 2010
Improving Lives. Improving Texas.
Objective
To give agricultural producers a
working knowledge of basic
marketing strategies that can help
manage some of the price risk
associated with agricultural
production.
Pricing before harvest reduces
price uncertainty and may
improve returns
• What tools are available to manage
g
market risk?
• How do these tools protect me as
prices change?
Basics of Marketing
• Self-appraisal
– Goals
– Attitudes towards risk
– Financial Resources
• Develop a Plan
• Gauge the Results
Importance of Price Risk
M
Management
t
• The individual producer is a price
taker with no power to influence
the price on any given day
• Can control when to establish a
price—select when the market
price is “good enough”
• Manage market opportunities
Marketing Strategies
1. Do Nothing
– Cash sales at harvest
2. Fix Price Now
– Cash forward contract
– Hedge
3 Set a Price Floor
3.
– Options
1. Do Nothing
• If you do no pre-harvest pricing
you are a speculator in the cash
market
• You accept all the price risk
between now and whenever you
decide to sell
2. Fix Price Now—Cash
C t
Contract
t
• Private negotiation in which the farmer
and the merchant agree now upon a
price of a commodity to be delivered in
the future
• Advantages
– Farmer and merchant lock in a price ahead
of time
– Helps eliminate the uncertainty caused by
price fluctuations
2. Fix Price Now—Cash
C t
Contract
t
• Disadvantages
– It didn’t eliminate the risk that the merchant
might default on the agreement
agreement.
– Similarly, farmers could default in the
delivery if prices had gone up substantially.
– It didn’t solve all the unforeseen price
changes related to product delivery (such
as quality,
quality measurement
measurement, and timing
timing, etc
etc.))
– Locked in to a set delivery point
2. Fix Price Now—Futures
C t
Contract
t
• A standardized agreement (legally
binding) to buy or sell a
commodity specifying quantity,
quality, maturity date, and delivery
(place and time)
• The only non-established variable
is price
Which Marketing Strategy is Best?
Cash
• Advantages
– No margin
g calls
– Locks in the basis
• Disadvantages
– M
Mustt deliver
d li
physical
h i l
commodity
– Must deliver to a specific
l
location
ti
Futures
• Advantages
– Not forced to deliver
physical commodity
– Not tied to a specific
delivery
y location
• Disadvantages
– Margin calls
– Still h
have b
basis
i risk
i k
Problem 1
•
•
•
•
You are a corn producer. It is May 1 and your
crop is up and doing good. You think current
high prices will not last and will decline before
harvest.
December corn futures are trading at $4.23.
You can forward contract at your local
elevator for $4.38.
$
The local basis for harvest
is usually +$0.20.
Sh ld you fforward
Should
d contract
t t or h
hedge?
d ?
What will be your expected price?
Problem 1
• Because basis is weak, you decide to
hedge (0
(0.15<0.20)
15<0 20)
• Sell in the futures market the number of
contracts
t t equall to
t the
th amountt off corn
you want to hedge
• Lock in a price of $4.43 if the basis is
normal
Expected Price = Futures plus Basis
Expected Price = $4.23
$4 23 + $0
$0.20
20 = $4.43
$4 43
Problem 1: Price Declines
Cash Market
Futures Market
Basis
May 1
Harvest bid of
$4.38
Sell Dec Corn at
$4.23
+0 15
+0.15
November
Sell cash corn at Buy Dec Corn at
$3.75
$3.55
+0.20
Change
$0.63/bu loss
+0.05
Cash price when $3.75
corn is sold
Gain on futures
position
$0 68
$0.68
Net sales price
$4.43
$0.68/bu gain
Problem 1: Price Goes Up
Cash Market
Futures Market
Basis
May 1
Harvest bid of
$4.38
Sell Dec Corn at
$4.23
+0 15
+0.15
November
Sell cash corn at Buy Dec Corn at
$4.70
$4.50
+0.20
Change
$0.32/bu gain
+0.05
Cash price when $4.70
corn is sold
Loss on futures
position
$0 27
$0.27
Net sales price
$4.43
$0.27/bu loss
Problem 1: Price Declines, Basis
Weakens
Cash Market
Futures Market
Basis
May 1
Harvest bid of
$4.38
Sell Dec Corn at
$4.23
+0 15
+0.15
November
Sell cash corn at Buy Dec Corn at
$3.65
$3.55
+0.10
Change
$0.73/bu loss
-0.05
Cash price when $3.65
corn is sold
Gain on futures
position
$0 68
$0.68
Net sales price
$4.33
$0.68/bu gain
Problem 1
Expected Price
5.30
5.10
4.90
4.70
4.50
Hedge (basis = +0.20)
Do Nothing
4.30
Cash Contract (basis = 0.15)
4.10
3.90
3.70
3.50
3.50
3.70
3.90
4.10
4.30
4.50
December Futures
4.70
4.90
Trading Strategies Involving Options
Factors to be Considered when
B i Options
Buying
O ti
• Buyer must decide strike price/premium
• Buyer must decide whether or not to
exercise
Sorghum Example
• Situation:
– You are a sorghum producer who
wants protection in case prices fall
by harvest
• Strategy:
– Buy a December put option
Determine Expected Selling Price;
December Corn is trading at $4
$4.17
17 per
bushel
Strike Prices
Put Premiums
4.20
0.60
4.10
0.50
4 00
4.00
0 44
0.44
3.90
0.41
3.80
0.33
3.70
0.28
Determine Expected Selling Price
Select
S
l tA
Appropriate
i t Futures
F t
Contract Month
December
Select Appropriate type of Option
Buy Put (right to sell)
Calculate Minimum Selling Price
Strike price
4.20
4.00
3.80
Subtract premium
- 0.60
- 0.44
- 0.33
Adjust for basis
- 0.60
- 0.60
- 0.60
Minim m price
Minimum
3 00
3.00
2 96
2.96
2 87
2.87
Profit and Loss from Buying a $4.00 put @ $0.44
1.00
0 75
0.75
0.50
The most you can lose is your
premium; potential gains are
unlimited
0 25
0.25
0.00
2.70
3.20
3.70
4.20
4.70
5.20
5.70
6.20
(0.25)
(0.50)
(0.75)
Profit
If Strike Price > Futures Price,
Price Profit/Loss = Strike – Futures – Premium
If Futures ≥ Strike Price, Loss = Premium Paid (Do not exercise option)
6.70
Buy $4.00 put at $0.44 sets floor price at $2.96
(basis = -$0.60)
$0 60)
Put Option Strategy
4.50
4.00
3.50
3.00
2.50
2.00
If Strike > Futures, Expected Price = Strike – Premium + Basis
If Strike ≤ Futures, Expected Price = Futures – Premium + Basis
Buy $4.00 put at $0.44 sets floor price at $2.96
(basis = -$0.60)
$0 60)
Put Option Strategy vs. Cash
6.00
5.50
0.44
5.00
4.50
4.00
3.50
3.00
2.50
2.00
Buy $4.00 put at $0.44 vs. Hedge (sell futures) at
$4 17 (basis = -$0.60)
$4.17
$0 60)
Put Option Strategy vs. Cash vs. Hedge
7.00
6.50
6.00
5.50
5.00
4.50
4.00
3.50
3.00
2.50
2.00
3.00
3.50
4.00
4.50
5.00
5.50
6.00
6.50
7.00
7.50
Buying Put Options
• Effectively creates a minimum
price contract
• Never the most profitable strategy
• Limits losses if prices go down
• Gains are unlimited if prices go up
• Expensive
Window Strategy
• Buy a put and sell a call
• Creates a price window with a floor and
ceiling
• Cheapens price floor strategy but
p
top
p side p
price limit
imposes
Floor = Put Strike price – put premium +
call premium – basis
Ceiling = Call Strike price – put premium + call
premium – basis
0.50
0.40
0.30
0.20
0.10
0.00
-0.10
-0.20
-0.30
-0.40
0.40
-0.50
-0.60
-0.70
-0
0.80
80
-0.90
-1.00
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
5.60
5.70
5.80
5.90
6.00
6.10
6.20
6.30
6.40
6.50
6.60
6.70
6.80
6.90
Sell a $5.50 Dec Corn Call for $0.20
The most you can gain
Th
i iis
the premium; potential
losses are unlimited
Profit
If Strike ≥ Futures, Profit = Premium Received (buyer will not exercise)
If Futures > Strike, Profit = Strike – Futures + Premium
Expected Price when selling a $5.50 call
option for $0
$0.20,
20 basis = -0.60
0 60
6.00
5 50
5.50
5.00
4.50
4.00
3.50
3.00
2.50
2 00
2.00
Expected Price
If Futures ≤ Strike, Price = Futures + Premium
If Strike < Futures, Price = Strike + Premium
Sorghum Example ((-$0.60
$0.60 basis)
•
•
•
•
Futures closing price: $4.17
$
Buyy a $4.00 put at $0.44
Sell a $5.50 call at $0.18
Price floor
= 4.00 – 0.44 + 0.20 – 0.60 = 3.16
• Price
Pi C
Ceiling
ili
= 5.50 – 0.44 + 0.20 – 0.60 = 4.66
(Net premium paid = $0.24)
2.00
3.00
0
3.10
0
3.20
0
3.30
0
3.40
0
3.50
0
3.60
0
3.70
0
3.80
0
3.90
0
4.00
0
4.10
0
4.20
0
4.30
0
4.40
0
4.50
0
4.60
0
4.70
0
4.80
0
4.90
0
5.00
0
5.10
0
5.20
0
5.30
0
5.40
0
5.50
0
5.60
0
5.70
0
5.80
0
5.90
0
6.00
0
6.10
0
6.20
0
6.30
0
6.40
0
6.50
0
6.60
0
6.70
0
6.80
0
6.90
0
7.00
0
Buy $4.00 put at $0.44 vs. Hedge (sell futures) at $4.17 vs.
Window (buy 4.00
4 00 put and sell $5.50
$5 50 call) (basis = -$0.60)
-$0 60)
Put vs. Cash vs. Hedge vs. Window
6.00
5.50
5.00
4.50
4.00
3.50
3.00
2.50
Corn Example
• Want to set a price floor for 2010
crop but afraid of locking in a price
that is too low
• December corn is trading at
$4.30/bu
• My basis is +$0.10
$0.10 the CBOT
Determine Expected Selling Price
Select
S
l tA
Appropriate
i t Futures
F t
Contract Month
December
Select Appropriate type of Option
Buy Put (right to sell)
Calculate Minimum Selling Price
4.10
3.90
Subtract premium - 0.72
-0.57
-0.47
Adjust for basis +0.10
+0.10
+0.10
Minim m price 3.68
Minimum
3 68
3 63
3.63
3 53
3.53
Strike price 4.30
Comparison of Expected Prices
7.50
7.00
6.50
6.00
5.50
5.00
4 50
4.50
4.00
C h
Cash
H d
Hedge
B Put
Buy
P t
6.90
6.80
6.70
6.60
6.50
6.40
6.30
6.20
6.10
6.00
5.90
5.80
5.70
5.60
5.50
5.40
5.30
5.20
5.10
5.00
4.90
4.80
4.50
4.40
4.30
4.20
4.10
4.00
3.90
3.80
3.70
3.60
3.00
4.70
3.50
4.60
Cash = Futures plus basis
Futures = Futures today plus basis
If Strike > Futures
Futures, Expected Price = Strike – Premium + Basis
If Futures ≥ Strike, Expected Price = Futures – Premium + Basis
Forward Contract and Buy a
C ll Option
Call
O ti
• FC at $4.40
$
• Buyy $4.80 call at $0.55
• Price floor:
FC price – call premium = $3.85
$3 85
• Price ceiling: none
Corn FC with Long Call
6.50
6.00
5.50
5.00
4.50
4 00
4.00
3.50
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
5.60
5.70
5.80
5.90
6.00
6.10
6.20
6.30
6.40
6.50
6.60
6.70
6.80
6.90
7.00
3 00
3.00
Long Call
FC
FC = Futures + Basis
If Futures > Strike price, Long Call = FC – Premium
If Strike Price > Futures, Long Call = FC – Premium + (Futures – Strike price)
Bull Call Spread
• B
Buy lower
l
strike
t ik price
i (SP1) callll option,
ti
4
4.40
40
@ $0.74
• Sell higher strike price (SP2) call option
option, 6
6.00
00
@ $0.32
• If Futures < SP1, profit (loss) = net premium
paid (most you can lose)
• If SP1> Futures < SP2, profit = Futures minus
SP1 + net premium paid
• If Futures > SP2, profit = Futures minus SP1 +
SP2 minus Futures + net premium paid
(most you can gain)
-$0.20
-$0.40
-$0.60
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
5.60
5.70
5.80
5.90
6.00
6.10
6.20
6.30
6.40
6.50
6.60
6.70
6.80
6.90
7.00
Bull Call Spread
$1.40
$1.20
$1.00
$0.80
$0.60
$0.40
$0.20
$0 00
$0.00
Futures or Options?
• Use options in markets likely to be
characterized
h
i db
by llarge and
d
sustained price moves
• Use options when there will be
problems in arranging financing for
a margin line
• Use options
p
when the ability
y to
manage a selective hedging
program
p
g
is q
questionable
Don't gamble; take all
your savings and buy
some ggood stock and
hold it till it goes up,
then sell it.
it If it don
don'tt go
up, don't buy it.
--Will Rogers
R
Option Strategies Continued
Mark Welch
Texas AgriLife Extension Economist
January 20, 2010
Long Butterfly
• Do not expect market to make
major move up or down
• Buy a call with lower strike price
• Sell 2 calls with intermediate strike
prices, at the money
• Buy a call with higher strike price
Long Butterfly
1. Buy a lower priced call
340 call for 50 cents
N t profit
Net
fit
1.20
1.00
0.80
0.60
0.40
0.20
0.00
3.00 3.10 3.20 3.30 3.40 3.50 3.60 3.70 3.80 3.90 4.00 4.10 4.20 4.30 4.40 4.50 4.60 4.70 4.80 4.90 5.00
(0.20)
((0.40))
(0.60)
Long Butterfly
2. Sell 2 Intermediately
yp
priced calls
370 calls for 30
Net profit
0 80
0.80
0.60
0.40
0.20
0 00
0.00
(0.20)3.00 3.10 3.20 3.30 3.40 3.50 3.60 3.70 3.80 3.90 4.00 4.10 4.20 4.30 4.40 4.50 4.60 4.70 4.80 4.90 5.00
(0.40)
(0.60)
(0.80)
(1.00)
(1.20)
(1.40)
(1.60)
(1.80)
(2.00)
((2.20))
Long Butterfly
3. Buy a higher priced call
400 call for 20
Net p
profit
1.00
0.80
0.60
0.40
0.20
0 00
0.00
3.00 3.10 3.20 3.30 3.40 3.50 3.60 3.70 3.80 3.90 4.00 4.10 4.20 4.30 4.40 4.50 4.60 4.70 4.80 4.90 5.00
(0.20)
(0.40)
Long Butterfly
Net profit from combined positions
Net profit
0 30
0.30
0.20
0.10
0.00
3.00 3.10 3.20 3.30 3.40 3.50 3.60 3.70 3.80 3.90 4.00 4.10 4.20 4.30 4.40 4.50 4.60 4.70 4.80 4.90 5.00
(0.10)
((0.20))
Short Butterfly
• Market may move up or down but
do not expect it to stay neutral
• Sell 1 higher priced call
• Buy 2 intermediately priced calls,
at the money
• Sell 1 lower priced call
Short Butterfly
1. Sell 1 higher priced call
400 call for 20
Net Profit
0.30
0.20
0.10
0 00
0.00
(0.10)
(0.20)
(0.30)
(0.40)
Short Butterfly
2. Sell 1 lower priced call
340 call for 50
Net Profit
0.60
0.50
0 40
0.40
0.30
0.20
0.10
0.00
(0.10)
(0.20)
(0 30)
(0.30)
(0.40)
(0.50)
(0 60)
(0.60)
(0.70)
Short Butterfly
3. Buy 2 intermediately priced calls
370 call for 30
Net Profit
1.10
1.00
0.90
0 80
0.80
0.70
0.60
0.50
0.40
0 30
0.30
0.20
0.10
0.00
(0 10)
(0.10)
(0.20)
(0.30)
(0.40)
(0.50)
(0 60)
(0.60)
(0.70)
Short Butterfly
N t profit
Net
fit from
f
combined
bi d positions
iti
Net Profit
0.20
0.10
0.00
(0.10)
(0.20)
(0.30)
Long Straddle
• Strong market move is expected
but could be either way; open
ended in either direction
• Buy a call, at the money
• Buy a put, at the money
Long Straddle
1. B
1
Buy a putt
370 put for 30
Net Profit
0.50
0.40
0.30
0.20
0 10
0.10
(0.10)
(0.20)
(0.30)
(0.40)
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
0.00
1.60
1.40
1.20
1.00
0.80
0.60
0.40
0.20
0.00
(0.20)
(0.40)
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
Long Straddle
2. B
2
Buy a call
ll
370 call for 30
Net Profit
Long
g Straddle
Net profit from combined positions
Net Profit
0.80
0.60
0.40
0.20
(0.20)
(0 40)
(0.40)
(0.60)
(0.80)
2.40
2.50
2.60
2.70
2.80
2.90
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
0.00
Short Straddle
• Do not expect the market to move
before options expire
• Sell a put
• Sell a call
((0.20))
(0.40)
((0.60))
(0.80)
((1.00))
2.50
2.60
2.70
2.80
2.90
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
Short Straddle
1. Sell a put
1
370 put at 30
Net Profit
0.40
0.20
0.00
(0.20)
(0.40)
(0.60)
(0.80)
(1.00)
(1.20)
(1.40)
((1.60))
2.50
2.60
2.70
2.80
2.90
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
Short Straddle
2. Sell a call
2
370 call at 30
Net Profit
0.40
0.20
0.00
Short Straddle
Net profit from combined positions
Net Profit
0.80
0.60
0.40
0.20
(0 40)
(0.40)
(0.60)
((0.80))
4.90
4.80
4.70
4.60
4.50
4.40
4.30
4.20
4.10
4.00
3.90
3.80
3.70
3.60
3.50
3.40
3.30
3.20
3.10
3.00
2.90
2.80
2.70
2.60
(0.20)
2.50
0.00
Long Strangle
• Expect the market to move either
way; but if it stays stagnant, the
losses are less than with a long
straddle
• Buy put, out of the money
• Buy call, out of the money
(0.20)
((0.40))
2.50
2.60
2.70
2.80
2.90
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
Long Strangle
1. Buy a call
1
call, out of the money
390 for 20
Net Profit
1.60
1.40
1.20
1.00
0.80
0.60
0.40
0.20
0.00
(0.20)
((0.40))
2.50
2.60
2.70
2.80
2.90
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
Long Strangle
2. Buy a put
2
put, out of the money
350 for 20
Net Profit
1.00
0.80
0.60
0.40
0.20
0.00
((0.20))
(0.40)
((0.60))
4.90
4.80
4.70
4.60
4.50
4.40
4.30
4.20
4.10
4.00
3.90
3.80
3.70
3.60
3.50
3.40
3.30
3.20
3.10
3.00
2.90
2.80
2.70
2.60
2.50
Long Strangle
Net profit from combined positions
Net Profit
0.80
0.60
0.40
0.20
0.00
Short Strangle
• Expect stable prices
• Compared to a short straddle,
premiums received are less and
so is profit potential
• Sell a call, out of the money
• Sell a put
put, out of the money
((0.20))
(0.40)
((0.60))
(0.80)
((1.00))
2.50
2.60
2.70
2.80
2.90
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
Short Strangle
1. Sell a put,
1
put out of the money
350 put at 20
Net Profit
0.40
0.20
0.00
Short Strangle
2. Sell a call,
2
call out of the money
390 call at 20
Net Profit
0.40
0.20
(0.20)
(0.40)
(0.60)
(0.80)
(1.00)
(1.20)
(1.40)
((1.60))
2.50
2.60
2.70
2.80
2.90
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
0.00
Short Strangle
Net profit from combined
positions
Net Profit
0.60
0.40
0.20
((0.40))
(0.60)
((0.80))
4.90
4.80
4.70
4.60
4.50
4.40
4.30
4.20
4.10
4.00
3.90
3.80
3.70
3.60
3.50
3.40
3.30
3.20
3.10
3.00
2.90
2.80
2.70
2.60
(0.20)
2.50
0.00
Call Ratio Spread
• Expect higher prices up to a
certain level; some fear that prices
may fall dramatically
• Buy an at the money call
• Sell 2 out of the money calls
(0.20)
(0.40)
2.50
2.60
2.70
2.80
2.90
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
Call Ratio Spread
1. Buy an at the money call
370 for 30
Net Profit
1.60
1.40
1.20
1.00
0.80
0.60
0.40
0.20
0.00
Call Ratio Spread
2. Sell 2 out of the money calls
410 for 20
Net Profit
0.60
0.40
0.20
(0 40)
(0.40)
(0.60)
(0.80)
(1 00)
(1.00)
(1.20)
(1.40)
(1.60)
5.00
4.90
4.80
4.70
4.60
4.50
4.40
4.30
4.20
4.10
4.00
3.90
3.80
3.70
3.60
3.50
3.40
3.30
3.20
3.10
3.00
2.90
2.80
2.70
2.60
(0.20)
2.50
0.00
Call Ratio Spread
Net profit from combined
positions
Net Profit
0.60
0.50
0.40
0.30
0.20
0 10
0.10
(0 20)
(0.20)
(0.30)
(0.40)
(0.50)
5.00
4.90
4.80
4.70
4.60
4.50
4.40
4.30
4.20
4.10
4.00
3.90
3.80
3.70
3.60
3.50
3.40
3.30
3.20
3.10
3.00
2.90
2.80
2.70
2.60
(0.10)
2.50
0.00
Put Ratio Spread
• Expect lower prices near term, but
limited move down; risk that prices
could move higher
• Buy 1 at the money put
• Sell 2 out of the money puts
(0.20)
(0.40)
2.50
2.60
2.70
2.80
2.90
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
Put Ratio Spread
1. Buy an at the money put
370 for 30
Net Profit
1.00
0 80
0.80
0.60
0.40
0.20
0.00
Put Ratio Spread
2. Sell 2 out of the money puts
300 for 10
Net Profit
0.40
0 20
0.20
(0.40)
((0.60))
(0.80)
(1.00)
5.00
4.90
4.80
4.70
4.60
4.50
4.40
4.30
4.20
4.10
4.00
3.90
3.80
3.70
3.60
3.50
3.40
3.30
3.20
3.10
3.00
2.90
2.80
2.70
2.60
(0.20)
2.50
0.00
Put Ratio Spread
Net profit from combined
positions
Net Profit
0.70
0.60
0.50
0.40
0 30
0.30
0.20
0.10
(0.20)
5.00
4.90
4.80
4.70
4.60
4.50
4.40
4.30
4.20
4.10
4.00
3.90
3.80
3.70
3.60
3.50
3.40
3.30
3.20
3.10
3.00
2.90
2.80
2.70
2.60
(0.10)
2.50
0.00
Call Ratio Backspread
• Expect higher prices, but do not
want to lose money if market
trades lower; do not expect stable
prices
• Sell 1 at the money call
• Buy 2 out of the money calls
Call Ratio Backspread
1. Sell an at the money call
370 for 30
Net Profit
0.40
0.20
(0.20)
(0.40)
(0.60)
(0.80)
(1.00)
(1.20)
(1.40)
(1.60)
2.50
2.60
2.70
2.80
2.90
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
0.00
Call Ratio Backspread
2. Buy 2 out of the money calls
410 for 10
Net Profit
1.80
1.60
1.40
1.20
1.00
0 80
0.80
0.60
0.40
0 20
0.20
(0.40)
5.00
4.90
4.80
4.70
4.60
4.50
4.40
4.30
4.20
4.10
4.00
3.90
3.80
3.70
3.60
3.50
3.40
3.30
3.20
3.10
3.00
2.90
2.80
2.70
2.60
(0.20)
2.50
0.00
Call Ratio Backspread
Net profit from combined
positions
Net Profit
0.70
0.60
0.50
0.40
0.30
0 20
0.20
0.10
(0.20)
(0.30)
(0.40)
5.00
4.90
4.80
4.70
4.60
4.50
4.40
4.30
4.20
4.10
4.00
3.90
3.80
3.70
3.60
3.50
3.40
3.30
3.20
3.10
3.00
2.90
2.80
2.70
2.60
(0 10)
(0.10)
2.50
0.00
Put Ratio Backspread
• Expect significantly lower prices
but do not want to lose money if
prices go higher; feels strongly
that prices will not stay where they
are
• Sell an at the money put
• Buy 2 out of the money puts
(0.20)
(0.40)
((0.60))
(0.80)
(1.00)
2.50
2.60
2.70
2.80
2.90
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
5.50
Put Ratio Backspread
1. Sell an at the money put
370 for 30
Net Profit
0.40
0 20
0.20
0.00
Put Ratio Backspread
2. Buy 2 out of the money puts
300 for 10
Net Profit
1.00
0 80
0.80
0.60
0.40
0.20
(0.40)
5.00
4.90
4.80
4.70
4.60
4.50
4.40
4.30
4.20
4.10
4.00
3.90
3.80
3.70
3.60
3.50
3.40
3.30
3.20
3.10
3.00
2.90
2.80
2.70
2.60
(0.20)
2.50
0.00
(0.20)
((0.40))
(0.60)
(0.80)
2.00
2.10
2.20
2.30
2.40
2.50
2.60
2.70
2.80
2.90
3.00
3.10
3.20
3.30
3.40
3.50
3.60
3.70
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
Put Ratio Backspread
Net profit from combined
positions
Net Profit
0.60
0 40
0.40
0.20
0.00
More Resources
• Risk Management Curriculum Guide
– http://agecoext.tamu.edu/resources/library/
risk-management-curriculum-guide.html.
• Online Options Trading Encyclopedia
– http://www.optiontradingpedia.com/
8.
Marketing Simulation
Exercise
Alternative Approaches
Alternative Approaches
1.. Sell 100% of production at harvest (Oct 15)
Se 00% o p oduct o at a est (Oct 5)
2. Sell a little each month of the year (10% for 10 g
g
months beginning on Jan 15)
3. Market according to a target price (Total Costs plus 10%)
4. Sell based on seasonal price tendencies by the calendar (Mar 1, Jun 15, Aug 1, Oct 15)
5. Sell based on seasonal price tendencies using Moving Averages to time sales
Seasonal Price Index for U.S. Corn
Seasonal Price Index for U.S. Corn
September 1998 – August 2008
Marketing Year
Percentt of Averaage
120
110
100
90
80
S
O
N
D
J
F
5 Yr
5-Yr
11/10/08
M
A
10 Yr
10-Yr
M
J
J
A
Marketing Results
Marketing Results
1. Harvest
2. Average
3. Target
4. Seasonal
5. Seasonal
plus MA
2005
2.04
2.31
2006
3.17
2.64
2007
3.62
3.89
2008
3.88
5.80
2009
3.73
3.88
2.04
2.33
2.31
3.17
2.74
2.73
3.62
3.84
3.72
4.57
5.78
6.10
4.25
3.98
3.87
December Corn 2009, avg price = $4.09
500
25%
25%
480
25%
25%
Sold 25%
4.6250
460
Sold 25%
4.1875
440
420
Sold last 50% at $3.72
Sold call for 33 cents
400
Harvest Economic Improvement
380
Crop Condition
360
Planting Survey
Crop Condition
340
Buy 340 Dec
call for 24 cents
Planting Intentions
320
300
1/2
2/2
3/3
3/27
4/27
5/25
BE to cover Total Costs = $4.15/bushel
6/22
7/20
8/17
9/15
10/13
Where Do We Go From Here?
• Input Use Efficiency
– Crop Rotations
– Hybrids/
Variety
– Conservation Tillage
– Soil and plant testing
– Precision ii
Application
•
Financial Management
– Budget//
BE analysis
– Cash Flow Cash Flow
Projections
– Crop Insurance
– Price Safety Net
– Marketing Plan
k i
l
December Corn 2010 Marketing Plan
600
Sell 25% Sell 25% Sell 25% Sell 25%
550
500
450
400
350
300
Manage the Margin
Do not focus only on absolute prices for either inputs or outputs
inputs or outputs
Analyze Focus on relative
relative profit fi
revenues margin
and costs
and costs
Mark Welch, Economist—Grain Marketing
JMWelch@ag.tamu.edu
@ g
(979)845‐8011
http://agecoext.tamu.edu/index.html
Agriculture and Natural Resources • Family and Consumer Sciences • 4-H and Youth Development • Community Development
___________________________________________________________________________________
Educational programs of the Texas AgriLife Extension Service are open to all people without regard to race, color, sex, disability, religion, age, or national origin.
The Texas A&M University System, U.S. Department of Agriculture, and the County Commissioners Courts of Texas Cooperating.
A member of the Texas A&M University System and its statewide Agriculture Program