Feuz Cattle & Beef Market Analysis
Buying Calls

Producers of fed cattle or feeder cattle can establish a maximum or "ceiling"  price to be paid for feed grain by buying a Call Option.  The ceiling price that the Call offers is the Strike price of the option plus the premium costs plus or minus the expected basis.  (The ceiling price will vary somewhat due to basis).

This strategy is executed by buying a Call option.  A lower strike price, more insurance, will result in a larger premium cost and the longer the time until the option expires will also result in higher premiums.  If the underlying market decreases the most a producer can lose is the premium.  So, purchasing a lower strike call at a higher premium will result in a lower net selling price if the market decreases compared to purchasing a higher strike call at a lower cost.  However, if the market increases, the lower  strike call will result in a lower ceiling price.  A producer must weigh the premium costs against the level of price insurance to determine what option strike price to purchase.

When the grain is purchased in the cash market, you usually would sell the call option if it had any value.  If grain prices have decreased below the strike price it is likely that the option will have no value and you simply let it expire.  However, if prices have increased above the strike price, then it will have value. Selling this call for that value is why you have purchased the price insurance.  If the option expires before you are ready to buy the grain, you can exercise the option and you then acquire a long
hedge position at the strike price.  Later, when you buy the grain, you then liquidate the long hedge by selling the futures contract.

Advantages

  • Establish a maximum price but no minimum price
  • There are no margin calls
  • You can choose the level of price insurance (strike price) that is best for you

Disadvantages

  • Premium cost;  purchasing price insurance a long time in advance of grain purchases can be expensive
  • Most grain options expire about 30 days prior to the futures contract expiration
Return to Hedging Alternatives
 
Description of a Long Fence
Description of a Long Hedge