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MN | I think if we are talking feeder cattle, one might look at buying corn call options, as a way of protecting yourself. Much bigger market with better efficiency.
That being said, when you talk about buying options as a way of hedging. It will always be less efficient that using the futures market. Because as you say, you get the right to exercise but not the obligation. Well having that right costs money. And there are plenty of people in Chicago that make lots of money selling puts. Hmmm... So if they make money doing it, why couldn't I the producer make the same money by carrying my own systemic risk? Of course, the answer is you can. By being diversified (getting rid of the unsystematic risk, or as much as you can)... by say, raising your own feed, having another job, raising different types of livestock, and having the capital to handle the market volatility you will have higher expected returns. Remember, when you offload risk, you also offload profit potential.
Now, we can always pick out periods of time (after the fact) that we can turn to and say, OH MAN, I should have bought puts there and I would have made so much money. BUT, hindsight is 20/20, making decisions in real time is much harder. We have to talk about probability if we want to talk about what an option 'should' cost. (And time, interest rates, etc...) Obviously, the guys (or gals) selling those puts think the probability for them to be exercised is very low. Or they would trade for more cash. The risk I see producers running into, is only buying when they appear "cheap" and of course never get exercised (or very rarely) and passing on protection when they look "expensive" which would be exactly the time when they should be purchased. This happens time and again in markets, people who try to "time" end up essentially buying high and selling low. Or in our example, taking protection when its not needed and not when they should have.
So, my recommendation would be to look at it as a strategy. If you are going to use options to hedge. Always use options to hedge. Have a system in place so that you buy the put at a defined period (say when you fill your lot) and sell the put back (or exercise) when you sell the cattle. And do it EVERY time.
Of course, I don't use options because I would rather keep the premium and commissions and carry the risk myself. Which I use as my marketing strategy. For many reasons, one of which is I don't feed contract size lots (sell about 8 every two weeks), so that would make it harder to perfectly hedge, and I believe that over the long run my strategy will yield better returns. | |
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puts and calls-feeder cattle
