“Many producers are currently storing canola, waiting for a higher price,” explains Blue. “While waiting for a more attractive price for canola, a strategy that some producers use is to sell call options.”
He says that canola remains as the only crop to have a functioning futures and options market trading in Canadian dollars. Access to the futures and options market can be either direct through an account with a futures brokerage firm, or indirect with a grain company that has a futures account.
“A grain company may offer futures and options related contracts to producers, and those contracts are usually offered as part of a physical delivery contract.”
First, he offers some background.
“Call options are tradeable each day that the canola futures market is open. Like futures, there is a seller for every buyer at a common price to have a trade occur. The buyer of a call option pays a fee – the premium – to purchase the right to buy canola futures at a certain price – the strike price – anytime during the option life.”
“The seller of the call option collects a premium in exchange for providing the option buyer the right to buy futures at that certain price. The risk of the option buyer is just the premium paid plus some commission.”
“The risk of the call option seller is that the futures price moves higher than the strike price by more than the premium collected. Each option is specific to a certain futures month and has a pre-defined expiry date.”
The following table shows various July canola call options as of January 20, 2020.
Table 1. Canola call options with July canola futures at $490 per tonne
|Call option strike price||Premium $ per tonne|
He uses this table as an example of the strategy.
“A producer has sold and delivered half of the 2019 produced canola, does not need cash flow in the short term, believes that the canola futures and/or basis levels will improve after February, has a futures account and the balance of the canola will store safely. The July canola futures price is $490 per tonne.”
He says that, although any of the options would be considered, the producer sells one or more 20 tonne July 510 call options and collects $6.50 per tonne.
“The July canola options expire on June 26. Meanwhile, the producer could remove the call option by buying that 510 call option in the market at any time. However, if the July 510 call option is held until expiry and if, at that time, the July futures price is less than $510 per tonne, that 510 call option will expire worthless and the producer keeps the $6.50 premium, minus broker commission.”
That premium collected adds to the eventual selling price of the canola.
“If the futures price at option expiry is above $510 per tonne, then the producer would be assigned a sell futures position at $510 per tonne, and still keep the $6.50 premium collected. The sell futures position that just replaced the call option could then be considered a futures hedge at $516 per tonne, considering the collected premium.”
“The newly created futures position would at some point be removed by buying July canola futures. Subject to the basis level, the result would be a much higher price than back in January, and some payment for storing the canola was obtained by collecting the option premium.”
“Sometimes this strategy is termed ‘selling a covered call,’ covered in the sense that the physical canola backs up the strategy. An option with a shorter life may have been used instead of the July option.”
He adds that in a carrying charge market – for example, higher futures prices in forward months – as the futures carrying charge is eroded away with time passing, the likelihood is greater of the 'short' call losing premium or expiring.
“In summary, the covered call strategy is a method of being paid to store canola while retaining the right to shop the market for the strongest basis for pricing the physical canola.”
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