With the Chicago Board of Trade options contracts that began trading in late 1984 and early 1985, farmers can now buy price insurance for their corn, wheat and soybean crops as well as for soybean meal. This new tool has both positive and negative dimensions. The positive aspects include (1) the ability to protect against declining crop prices while retaining the opportunity to gain if prices rise, (2) increased marketing flexibility in case you price your crop before harvest but yields are severely reduced by adverse weather. or disease and (3) the fact that options markets are a less complicated tool than direct sales in the futures market. On the negative side of the ledger, options markets make your marketing job more complex because of new terminology and the wider range of pricing alternatives that now are available. Also, in deciding how and when to market your crops as effectively as possible, you need to watch what's happening in the options markets along with cash, futures and forward contracting prices.

How Price Insurance Works

There are several ways options markets can be used in marketing grain (and livestock), as well as in feed purchases. The simplest and most direct use is for buying price insurance, in effect insuring that your selling price will not be below some specific level. You can do this in much the same way as you would buy insurance for your vehicles or farm buildings. Grain options contracts are available for the same delivery months as futures contracts. The options markets provide several different price insurance levels to choose from, each having a different insurance premium. In case of 1985-crop soybeans, for example, potential insurance levels ranged from $5.75 (Chicago price) to $7.50 per bushel in 25 cent increments. These insurance levels are called strike prices. The strike prices are fixed during a given marketing year, except that lower or higher strike prices may be added in times of rising or falling market prices. Once a new strike price has been added, it continues to be available until the option contract for that delivery month expires. In contrast to the strike price, the insurance premium can change daily and is determined by the interaction of buying and selling orders in the trading pit at Chicago. The premium is the cost of buying price insurance and must be paid when the option contract is purchased. In addition to the premium, option purchase costs include a commodity brokerage fee that typically is about one-half to one cent per bushel on 5,000 bushel options contracts.

The easiest way to obtain price insurance for your crop with the options market is by buying put options from a commodity broker. It is important to note that there are two separate options markets for each commodity: (1) puts and (2) calls. For trading to take place in either market, a buyer of the option and a writer or seller of the option are required. Buying a put, gives you the right but not the obligation to sell your product on the underlying futures contract at a specific price. Buying a call option gives you the right but not the obligation to buy a product on the underlying futures contract at a specific price. The underlying futures contract is the one with the same delivery month as the option. The call market is used commonly for price protection by processors, exporters and livestock feeding operations that want to insure a maximum purchasing price for grain or soybean meal.

In buying puts to insure a minimum selling price, the initial outlay for the premium and the brokerage fee are your total financial exposure in options markets. Unlike futures trading, if you buy options you will not be asked to deposit additional money with the broker, no matter how high or how low prices go. If prices are low at harvest time and you had purchased put options earlier at a strike price above the current futures price, you would be in a position to collect on your insurance policy. You could do that by selling your grain in the local cash market and also selling your option at an increased premium value to close out your market position. If prices are sharply above your initial strike price, your put option would probably be worthless so you'd let it expire and take the higher cash price.

Example Put Options Trading

Let's say you expect to produce 10,000 bushels of soybeans and want to insure them for November delivery at a Chicago equivalent price of $5.50 per bushel. However, you may also want to retain the opportunity to gain from higher prices if the market should strengthen, so you decide to forward price with the options market. From price records, you note that you have a normal harvest-time basis of about 40 cents. In other words, your local harvest-time prices normally run about 40 cents under November futures. Thus, your equivalent local price with a $5.50 strike price would be about $5.10 per bushel. (Actual local prices would vary from area to area, depending on your local basis.) Next, you note that the premium for a $5.50 put option—say in late spring—is $.15 per bushel. This plus a commission charge and interest on the premium totaling about two cents a bushel would be your total cost of buying price insurance. That reduces your local minimum selling price to about $4.93 per bushel ($5.50-.40 basis-.15 premium-.02 costs=$4.93).

Let's say you go ahead with this insurance program because your financial position won't let you risk lower prices, and you think prices could be considerably lower at harvest. Your insurance premium—to be paid when you buy the put options—would be $1,500 on your total crop, or $6 per acre with a 40 bushel per acre yield.

Suppose that by harvest time Chicago futures have dropped to $5.00, with local cash prices at $4.60 per bushel. In this case, you would probably want to sell your option to collect on your insurance policy. In other words, you would probably trade out of your option rather than exercise (exercising is converting it to a futures position). In this case, your option should be worth at least $.50 per bushel to the trader who would be purchasing it. If he/she bought the put, it carries the right to sell futures at $5.50, and repurchasing futures at $5.00 would generate a $.50 return. If traders expect still lower prices and you trade out of your option a few weeks before it expires (expiration of November options is about mid-October), it could be worth slightly more than $.50 per bushel. In this case, your profit on this option ($.50 minus your initial $.15 premium = $.35) would be added to your cash price. After deducting two cents trading cost, your net price would be $4.93 per bushel, $.33 above the harvest-time cash market.

Now, let's take the case where the market rose sharply above your original insurance level, to $7 on November futures. In this case, exercising your option would generate a $1.50 per bushel loss (selling futures at $5.50, buying back at $7) so your $5.50 put would probably be worthless and you would let it expire. Local cash prices would be about $6.60, although your net price would be $.17 lower due to your initial $.15 premium plus $.02 trading cost. In this case, you would be able to participate in a rising market after your initial pricing decision. That's unlike forward contracting at the local elevator or hedging in the futures market, where you protect against down-side risks but remove the opportunity to gain from higher prices.

Table 1. Insuring Soybean Prices by Purchasing Put Options


Falling Prices



Cash Transaction

Options Transaction


Late May

Expected crop: 10,000 bu.

Expected cash price, $.40 under Nov. futures, Min. selling price (MSP) $5.50-.40-.15-.02 = $4.93

Buy 10,000 put options, $5.50 strike price (Prem. $.15/bu.; trading cost $0.02)


Early October

Harvest & sell 10,000 bu. at $4.60 cash price. Add $.35 options return minus $.02 trading cost = $4.93 net price.

Offset option, with futures at $5.00. Options premium valued at $.50-$.15 original premium = $.35 trading return.


Rising Prices


Early October

Harvest & sell 10,000 bu. at $6.60 cash price. Deduct initial options premium $.15 & $.02 trading costs = $6.43 net price.

Let option expire. Exercising would give $1.50 per bushel loss.

When to Use Options

Note that from an after-the-fact analysis, options markets will almost always come out as your second-best marketing alternative. With declining prices in the above example, you would have avoided the premium cost by contracting at a local elevator or hedging directly in futures contract. And with rising prices, you would have been better off by staying completely un-priced and avoiding premium costs. But marketing decisions cannot be made from hindsight and always involve uncertainty. If you can't risk lower prices but feel there is some reasonable chance the market will strengthen, it may make sense to use the options market. And you can use options in, combination with hedging or contracting. You can use options to insure a minimum selling price and protect your financial position, and then contract or hedge at a higher price if the market rallies sharply. Or you can hedge or contract to protect against lower prices, and buy call options to benefit from a possible rising market. Sometimes a hedge or forward contract plus call option purchases will provide the same degree of price protection and marketing flexibility as put options, but at substantially lower premium costs.

Options also provide added flexibility in case of crop problems. In our earlier example, suppose you had priced 10,000 bushels of beans in the options markets and were hit by severe drought that cut your crop yields 50 percent below normal, and that market prices rose sharply. In that situation, you could let your option contracts expire with no problem, except that you would be out the initial premium. Your market position could be much more complicated with an elevator contract calling for delivery of 10,000 bushels, when you only produced 5,000 bushels and had to buy out the other half of the contract at $6.50 or $7.00 per bushel.

What Affects Option Premiums?

Option premiums are influenced most by the difference between the underlying futures contract price and your strike price. They also are influenced by market volatility, interest rates and length of time until the option contract expires. After the expiration date, an option becomes worthless. Options contracts on grain expire approximately the second Friday of the month before the underlying futures contract expires. In general, the cost of buying put options will be relatively low when futures prices are well above your strike price, and vice versa when prices are well below a given strike price. This means one important time for cash-grain producers to watch the options markets for new-crop corn and soybeans is during the spring fieldwork season. That's a time of year when cash and futures prices have a strong seasonal tendency to increase.

Other Uses of Options in Grain Marketing

Other possible uses of options markets in grain marketing include (1) purchases of call options to protect against rising corn and/or soybean meal costs in livestock and poultry feeding, (2) purchases of call options as a substitute for storage, (3) to protect against reduced government deficiency payments resulting from rising crop prices, (4) as a tool for "earning" storage income by writing options and (5) as a tool for "fencing" crop returns by setting upper and lower limits on potential prices and reducing insurance costs below those of options purchases.

Protecting Against Rising Feed Costs—This can be accomplished by purchasing call options equivalent to the expected future volume of corn or soybean meal purchases, for the contract delivery month most closely matching the expected timing of cash purchases. Corn options contracts are available in 5,000 bushel contracts, while meal option contracts are available in 20 and 100 ton contracts. If prices rise sharply after call options are purchased, increased feed costs in the cash market will be offset or partially offset by an increased value of the call options, which would be sold when the corn or soybean meal is purchased.

Substitute for Storage—To sell grain at harvest but retain the opportunity to benefit from strongly rising prices, producers can offset harvest sales by buying call options. If futures prices rise significantly above-the initial strike price,. the options contracts should increase in value. If prices decline, the producer would lose only his/her initial premium payment plus a small brokerage charge. If you use this alternative, however, keep in mind that distant futures prices at harvest usually reflect a seasonal increase in cash prices due to seasonal price patterns and post-harvest strengthening of the basis (differential between cash and futures prices). When selling grain at harvest and buying call options, you give up these sources of post-harvest improvement in grain prices but retain the opportunity to gain from unusual developments that could bring a greater than normal seasonal rise in cash prices.

Hedging Deficiency Payments With Options Markets—The 1985 Farm Act provides deficiency payments for participants in feed grain and wheat programs if the U.S. 12-month marketing year average prices fall below specified target prices. Producers who store their crops beyond harvest have a kind of automatic deficiency payment hedge, since rising cash prices and increased value of the crop would offset shrinking deficiency payments. But if the crop is sold at harvest, rising prices would reduce deficiency payments and the producer would have no offsetting increase in cash value of the crop since his/her crop would already have been sold. To partially protect against such risks, the producer could purchase distant call options, preferably the September or December contracts. With sharply rising cash and futures prices, the call options would increase in value to offset the shrinking deficiency payments. Complete protection of deficiency payments is not automatic and/or guaranteed by purchases of call options. Deficiency payment protection would require monitoring changes in options premiums as futures prices change, as well as careful timing of call option

sales to close out the position. But with attention to these areas, call options can help insure against a drastic decline in government deficiency payments after the crop has been marketed.

Writing Options to Earn Storage—This alternative is more risky than purchasing options. Writing or selling options gives you a maximum potential return equal to the initial premium when you initiate the trade. At the same time, your loss potential is the amount of adverse price movement away from your strike price. For example, let's say your write a soybean call option at a $5.00 strike price, in order to collect a 15C premium, and the underlying futures price later moves to $9.00 per bushel. In that case you have losses in the form of margin calls totaling $4 per bushel ($20,000 on a 5,000 bushel contract). If the underlying futures price stays at or below $5.00 per bushel, you will eventually be able to collect most or all of the original premium.

Where to Get Current Premium Quotations for Soybean Options

There are only a few readily available sources of current options quotations other than regular contacts with commodity brokerage offices. These include (1) the Wall Street Journal, (2) the New York Journal of Commerce, (3) market news broadcasts on WOI radio at Iowa State University (640 on AM dial) and (4) the Agri-View market information service, a cooperative effort of Iowa State University and Iowa Public Television Broadcasting Network. Agri-View provides a daily source of options quotations, including premiums on livestock and both new and old-crop corn and soybeans. The Wall Street Journal and Journal of Commerce options quotations cover only the nearby three options delivery months and exclude new-crop pricing opportunities until early summer.