WRITTEN DECEMBER 18
Throughout the month of December 2008, we’ve seen fall 2009 canola prices range from just over $8 per bushel to $9 per bushel for November delivery throughout Alberta. The higher prices many remember from this past summer are long gone. So, what’s a canola producer to do?
Historically speaking, canola at $9 is a very attractive level to price the oilseed. On the other hand, producers still reflect back to the drought of 2002 when forward-priced canola contracts had to be bought-out due to lack of moisture. That experience caused many to become averse to forward contracting. However, the alternative is to do nothing. By doing nothing, the price could go up, or go down. It’s a flip of the coin.
One scenario to contemplate as part of a marketing plan is to sell (forward price) a bit of physical canola and, at the same time, match that sale with the purchase of a canola call option. I’ll give you an example, but first, keep in mind these points:
Canola futures change throughout the day
Canola basis levels can change daily and differ from buyer to buyer
Canola call options are NOT
the most liquid product (i. e. trading is sparse)
Options can be bought, and then either sold or converted to a futures position
Options can expire worthless
Buying options costs money (don’t forget about fees), but the risk is limited
For our example, let’s put November 2009 futures at $426 per tonne, which works out to a typical cash price of $9 per bushel. With a strike price of $425, the option cost for a load is about $1,800, but the futures need only rise by $42 to break even. (See the chart.) Note that if the NOV futures did rise by $42, the option may be worth even more than that $42 because of remaining time value.
If NOV canola futures rises to $499, here’s what can happen: NOV $499 less option strike price of $425 less cost of $43 equals $31. So on a 42-tonne truckload, your option strategy pays you $1,302 ($31 times 42 tonnes), or 70 a bushel. Add that 70 to the forward price of $9, and the total price is now $9.70.
In this example, the canola price, including the option profit, would exceed the deferred delivery price of $9.00. Meanwhile, the deferred delivery contract guarantees delivery space and cash flow for that time-frame. Buying the call option has provided limitless upside potential if the futures rally — anytime from the time of buying it until the option expires in October. Also, if it did happen that a hailstorm reduced your canola production, the call option could be sold to help defer possible costs of buying out the cash contract.
ON THE OTHER HAND…
Let’s say that by the end of October 2009, NOV canola futures have instead continued to drop and are now at $399. If the call option was held until then, the option would just expire worthless and the $43 premium would be lost. The forward-priced cash canola would be worth a net of $8.02, the minimum price in this example, and still a good price historically. Remember, though, that for any canola unpriced in advance of this futures decline, the cash prices would also have dropped substantially.
With a strike price at $600, alternatively, the out of pocket cost is only in the $250 range. However, NOV futures would have to hit $606 just to breakeven — not a common sight in our canola history, although it can happen. This might be a less expensive endeavour for a first-time option buyer to use.
TWO OTHER ALTERNATIVES
For fall 2009 canola pricing you could also consider (1) basis contracts (i. e., just locking in the basis with a buyer and waiting for an acceptable futures price to complete the pricing), and (2) negotiating a forward price in conjunction with a spot price (i. e., deliver and price some canola now in exchange for an attractive new crop contract price). Be sure to check which futures month the buyer is applying to a particular delivery month. For example, some buyers will use NOV futures for November deliveries and others use JAN futures for November deliveries.
Note: Special thanks to Neil Blue for his input on this article. Neil will be hosting more FutureSim classes in the upcoming months and I encourage those looking to further their education on futures and options to attend. FutureSim is an interactive learning experience.
Shelley Wetmore is owner of Market Master, a feedgrain brokerage and consulting service based in Edmonton. You can reach her toll free at 1-800-440-8390 or visit www.grain-watchdog.com.