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SELL CASH GRAIN & BUY CALL OPTION
FEATURES
* Immediate Delivery
* Futures Market Portion Priced at Time of Transaction, but Buying the Call Option Allows User to Take Advantage of a Futures Rally prior to Expiration of the Option
* Basis Priced Immediately
* Payment for Cash Grain Portion Received Immediately
DEFINITION
This strategy is an alternative which grain is sold for immediate shipment at current prices. The second portion of this strategy is to purchase a call option on futures. A call option gives the buyer the right to buy a futures contract prior to expiration at the strike price associated with the option. Hence, if the futures market rallies to or above the strike price, the option can be exercised and if the proceeds are greater than the premium originally paid for the option, including commissions are fees. If the futures market declines, the option will decrease in value or become worthless. This allows the seller of cash grain to receive cash immediately while allowing the buyer of the call option to participate if the market rallies. Often the purchase of a call option can be purchased for less than it may cost to store grain. This strategy can be referred to as "reinventoring" grain.
ADVANTAGES
* Allows seller of cash grain to receive money immediately.
* Allows buyer of call option to participate in a price rally if futures price rallies prior to expiration to option.
* Limited risk. Since the purchase of a call option in this situation could be viewed as a speculative trade, the risk is limited and defined to the price of the option premium paid plus commissions and fees.
* This alternative may eliminate the sellers risk of quality deterioration of stored grain if delivery is made immediately.
DISADVANTAGES
* Does not allow purchaser of option to lock in carry charges if available unless used in combination with a To-Arrive Contract.
* All or most of option premium can be lost if futures price declines or does not rally.
* Typically the rally in the premium of an option is not as great as the rally in the futures price, (i.e. futures market rallies $0.10 option premium may only rally $0.05).
EXAMPLE
It is October 15th and FREMAR is bidding $1.80 for corn. You feel that the corn market is going to rally higher, but you need cash right now to pay some bills. You see that you can purchase a July $2.60 corn call for 12 cents per bushel. Currently July futures are at $2.52. You think that this is a good buy so you instruct FREMAR to sell your cash corn and purchase a July call for your account.
It is June 1st and the market has rallied due to some dryness in the cornbelt. Currently your July call is worth 25 cents. You feel the market has reached it's top, so you instruct FREMAR to sell your call. In this case, you netted 13 cents more than if you would have just sold the cash corn.
However, the market could have not rallied and the premium you paid could have been lost.
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