Should I use a call option or a bull call spread?

What happened

We’ve had numerous questions from farmers who are either looking to sell extra corn out of the field or take advantage of the recent rally in soybeans and make sales.

Why this is important

In the case of corn, many feel like they’re giving corn away and would like to stay in an ownership position, but they don’t want to pay for commercial storage and take on market risk. The same is true for soybeans. However, the soybean market has rallied unlike the corn market, which is trading close to contract lows. In both cases, the desired outcome is the same: sell cash and retain ownership. But how?

What can you do?

The first question is what type of re-ownership. Do you want a position where the risk is fixed and upside price potential is unlimited, or would you be willing to spend less money for a position that has fixed risk and fixed profit potential?

If you want unlimited price appreciation potential for your position, then you want to consider buying a call option. A call option provides the owner the right (not the obligation) to own futures. Most call options that are purchased are likely offset, which means the owner sells it back into the marketplace. In some cases, call options expire without value, as they run out of time when the underlying futures market is below the strike price at the option’s expiration date. Call options that are in the money can also be exercised, which means turned into a long futures position. However, exercising exposes you to the unlimited risk of futures. To avoid this, most options that have value are sold. The real key for purchasing a call option is that it becomes a catalyst to make cash sales while being able to retain ownership.

If you want to spend less and are willing to live with a fixed profit potential position, then a bull call strategy may be your choice. Here, you purchase a call option with a strike price near where the futures are trading and sell an out-of-the-money call. The rationale here is that, when you sell a call against a purchased call, the premium for the short call is immediately applicable to the purchase of the long call, thus reducing your out-of-pocket expense. This may may be desired if you believe there is only a moderate amount that the underlying futures price can rally, or if at option expiration date, the futures market is above the sold call strike price. This is the level where the bull call spread has a maximum spread value, meaning fixed gain potential, regardless of how high the futures market rallies above the sold strike.

Whether you choose to use a call option or bull call spread is a personal preference. While it would be nice if either position could make money, the important thing to remember is the function of the strategy. It creates the action of selling cash and reducing exposure to market price, basis, and storage cost. While not an absolute statement, if a call option or a bull call strategy loses money, it is likely that storing grain would also have lost money.

There are many tools to use that will help mitigate your risk and provide opportunity. Before entering into any position, talk to a professional. Learn what may work best for your operation, considering your personal situation. Learn the risks and rewards to prepare yourself for any market move.

Editor's Note: If you have any questions on this Perspective, feel free to contact Bryan Doherty at Total Farm Marketing: 800-334-9779.

Disclaimer: The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Individuals acting on this information are responsible for their own actions. Commodity trading may not be suitable for all recipients of this report. Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Examples of seasonal price moves or extreme market conditions are not meant to imply that such moves or conditions are common occurrences or likely to occur. Futures prices have already factored in the seasonal aspects of supply and demand. No representation is being made that scenario planning, strategy or discipline will guarantee success or profits. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Total Farm Marketing. Total Farm Marketing and TFM refer to Stewart-Peterson Group Inc., Stewart-Peterson Inc., and SP Risk Services LLC. Stewart-Peterson Group Inc. is registered with the Commodity Futures Trading Commission (CFTC) as an introducing broker and is a member of National Futures Association. SP Risk Services, LLC is an insurance agency and an equal opportunity provider. Stewart-Peterson Inc. is a publishing company. A customer may have relationships with all three companies. SP Risk Services LLC and Stewart-Peterson Inc. are wholly owned by Stewart-Peterson Group Inc. unless otherwise noted, services referenced are services of Stewart-Peterson Group Inc. Presented for solicitation.

About the Author: With the wisdom of 30 years at Total Farm Marketing and a following across the Grain Belt, Bryan Doherty is deeply passionate about his clients, their success, and long-term, fruitful relationships. As a senior market advisor and vice president of brokerage solutions, Doherty lives and breathes farm marketing. He has an in-depth understanding of the tools and markets, listens, and communicates with intent and clarity to ensure clients are comfortable with the decisions.