Use Covered Calls To Turn A Fair Year Into A Good One – for Sep. 6, 2010

This year has been nerve wracking for many farmers in Western Canada. As I write in August, I already hear things like “I want to get this over with and start on next year.” I truly admire the farmers who can go through a rough year and then say, “Well there’s always next year.”

When I speak at meetings, I usually talk about “the good years” farming and farmers have had since I got into the agricultural industry 40 years ago. There have been about nine good years with decent crops and decent prices. There were about as many bad years. And there have been more or less fair years on both sides of the good and bad years.

Then, a couple months ago a farmer told me that he had farmed just over 30 years and the way he figured it, four of those years brought in 80 per cent of his farm income. That’s more or less the way I see it too. He missed 1972, 1973, 1974 and most of 2008 and 2009. When I include those years I see we had about nine good years. The farming industry had about nine real bad years but farm income programs offset some of that. Often, any farmer who qualified for farm income programs didn’t slide back financially too much in those really bad years. Of course with the CAIS program if you had two bad years close together your reference margin would drop and the farm income program more or less stopped working for you.

I visited John Kapiki years ago northeast of Edmonton at St. Andrew, Alta. One farmer said he had 20 good crops out of 22. Since then they have had drought a couple times and that hurt. And some years they had poor prices so it’s not that they had 20 “good” years, just 20 good crops.

My question to you is this: during your farming career, how many good years have you had on your farm? And if you’re a young farmer, do you think you face nine good years out of 40? Can you survive on that? I mentioned this to one young farmer the other day and he more or less said, “I’ve had two good years already out of five.” Another young farmer who runs cattle would likely tell me he’s had one, maybe two good years in his 13 year career. He said making hay for his herd made him old quickly.

CONTROL OVER GOOD AND BAD YEARS

Just where am I going with this line of thinking? First of all, we have to ask the question: why or how come the grain grower made 80% of his money in just four years? Was it weather? Was it prices he sold at? Was it variable costs, such as seed, fertilizer and so on? I don’t think it was lack of knowledge. Most farmers these days know how to grow a crop. Farmers can buy seed of varieties that have the genetic potential to grow a good crop. Sure, today’s equipment might add a few bushels per acre, but that shouldn’t make the difference between banner years and poor ones.

As for the type of land, well I’m not sure that makes a whole lot of difference. Most farmers are smart enough to know that if they farm at, say, Humboldt that their crops stand a pretty good chance of yielding to their genetic potential, so they feed the crops accordingly.

In dryland parts of the country, farmers have learned not to spend too much on the crop because moisture or lack of it makes or breaks the crop, not the amount of fertilizer they use. This makes me think the type of land is not the issue.

If it’s not land or inputs, how come four growing years contributed 80 per cent of the income on one farm in a career of 32 years? How come seven to nine good years has been normal in many parts of the prairies since 1970? The question remains: Can you and your fellow farmers control or influence how many good years you will have going forward?

In my humble opinion I doubt you can truly influence how many good years you will have during your farming career. Not that I want to be a pessimist, and I wouldn’t say the good years were an accident or luck. But I don’t believe most farmers can predictably put together the conditions that lead to a good year. Too much of what makes a good year is out of your control.

If you don’t believe that then ask yourself what conditions helped make your good years “a good year.” Then ask yourself how much control you had over those three or four things. I would say a combination of good crops, the right crops, good quality, good prices and good selling teamed up to make a year “a good year.” You might be able to control one or two of those conditions but I doubt you can control all five.

For thousands of farmers, 2010 likely will go down in history as the year where if something could go wrong, it did. And there wasn’t a whole lot most farmers could do about it.

Is there a solution? I hope so. But it will take a new set of skills and some work. It might take a new overall financial plan like the five-legged stool I often write about. As you know, I manage our own money and my decisions are reversible. I own stocks and make money three or four ways: by collecting dividends; earning capital gains; bringing in cash by selling covered calls (like renting out our stocks); and through earning some interest on other money. Once we get good at the skill the broker might let us sell puts on rising stocks and we can always buy puts which act as insurance if a stock drops.

LEARN TO SELL COVERED CALLS ON CANOLA

Through these different strategies, I have many opportunities per year to make money. A typical farm has one or two opportunities to make money. The news usually reports the bad news more than the good news and most of the media does not understand the skill of selling covered calls.

Selling covered calls is a rare skill in Western Canada and not understood very well. From history, I know stocks go up 27 per cent of the time, down 7 per cent and sideways 66 per cent of the time. When we understand this and understand our stocks, we can manage our option strategies for rising, falling or sideways markets. I learned to use this strategy and write about it often because I hope many farmers will learn the skill and then use it to make more money from their crops and from their stocks.

Here’s how. In the fall of 2009 I wrote how a farmer could sell about 4,000 bushels of canola at around $8.50 a bushel, then buy 1,000 shares of a company called Tech Resources (TCK. B), and sell a call on those shares for May for a strike price of $34. The premium at the time was around $4 per share. That means the 1,000 shares, 4,000 bushels worth of canola, would have brought in $4,000 or roughly $1 bushel of extra cash. Furthermore, that cash would be taxed as capital gain which is only half taxable. By the way the shares have ranged in price from $34 to $47 and now back down to $34.

Another example I can repeat goes like this. In March, 2009 some farmers bought 1,000 shares of Potash Corp (POT) and sold calls for October and collected $18 per share or $18,000 on the spot. Come October the shares were within $1 of the $100 so those same farmers could have sold a call for April 2010 and collected another $12 per share for a total of $30. In April the shares were around $112 and going down to bottom at $90. In April those shareholders could have sold another call for a net gain of another $8 to $10 for a total of around $40 of cash gains per share. When I wrote this article in August the price was $116 but on August 16, BHP offered US$130 for shares of POT and the market jumped to C$144. The farmers who sold calls on their shares had most of that money months ago.

Anyway, back to selling calls on canola.

Since that time I have talked to several brokers who do sell calls on canola. Basically, when you have canola in the bin you can sell calls on that canola and collect a premium (rent). This strategy needs some watching, work and understanding and that is why I have tried to teach the skill on stocks, which might be more or less threatening than selling calls on your canola. The bottom line is once you learn the strategy on some stocks you can apply it to sell calls on canola. You need a different broker and different trading account but the idea is the same.

Many investors still follow the buy and hold strategy that worked so well in the past. Yet in the past 10 years the S&P index was flat. Stocks like GE, DELL and others are well down from their highs. GM disappeared, Ford has tanked and Nortel disappeared. Meanwhile prices of gold and silver shares are hitting new highs.

Knowing these statistics for stocks and for good years in farming I do wonder why so many farmers spend most of their energy, brain power and other resources to manage a business with one way decisions and uncontrollable events that has done well about 25 per cent of the time the past 40 years. Our stocks can make us money most of the time if we are prepared to learn and work a bit, and we can reverse our decisions in a heartbeat.

If economies around the world need until 2017 to even try to recover we likely have had the small part of the V recovery (some call it a J in reverse) and many stocks could be flat lined for years. (Like an L). I hope to keep bringing in cash during that time by selling covered calls. You can learn that strategy too. At the same time, events around the world point to a higher floor on crop prices. But costs are rising, too.

There might be a few good years in growing crops in the years ahead. I hope so. But if you can learn another skill then you likely can improve the odds of having more “good years.”

Andyismostlyretired.Hemanageshismoney andpublishesanewslettercalledStocksTalk whereheexplainsindetailwhathedoes withhisstocks.Ifyouwanttoreaditfree foramonthgotoGoogle,typeinStocksTalk, clickonfreemonth,clickonform,filloutfour linesandclicksubmit.Orsendanemailto [email protected]

About the author

Freelance Writer

Andy was a former Grainews editor and long-time Grainews columnist. He passed away in February 2017.

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