AGRICULTURAL RISK MANAGEMENT. Global Grain Geneva November 12, 2013

Transcription

1 AGRICULTURAL RISK MANAGEMENT Global Grain Geneva November 12, 2013

2 Managing Price Risk is Easier to Swallow Than

3 THE ALTERNATIVE

4 Is Your Business Protected

5 Is Your Business Protected

6 Is Your Business Protected

7 Is Your Business Protected

8 Are Your Grains & Oilseeds Protected

9 Key Topics for Your Business PROTECTION OPPORTUNITY CORRELATION CME Group Futures & Options LIQUIDITY VARIETY EFFICIENCY

10 Chicago Mercantile Exchange (CME) Chicago Board of Trade (CBOT) New York Mercantile Exchange (NYMEX) Commodity Exchange (COMEX) Kansas City Board of Trade (KCBT) 10

11 CME Group Product Complexes Commodity Interest Rates Foreign Exchange Equities What is Your Market Exposures? Commodity Prices Energy Costs Financial Portfolio Currency Fluctuations Energy Metals Alternative Investments 11

12 Which came first or

13 Neither Grains & Oilseeds

14 Agricultural Commodity Product Complex Grains and Oilseeds: Corn Futures, Options & Swaps Wheat Corn Spread Options Mini-sized Corn Futures Ethanol Futures, Options and Swaps Oat Futures and Options Rough Rice Futures and Options Soybean Futures, Options & Swaps Mini-sized Soybean Futures Soybean Meal Futures and Options Soybean Oil Futures and Options Soybean Corn Price Ration Options Crude Palm Oil Futures CBOT & KCBT Wheat Futures, Options & Swaps Mini-sized Wheat Futures Corn, Wheat, Soybeans, SoyOil, SoyMeal Calendar Spread Options Livestock: Feeder Cattle Futures and Options Live Cattle Futures and Options Lean Hogs Futures and Options Live Cattle & Lean Hog Calendar Spread Options Dairy Products: Butter Futures and Options Butter Spot Call Cash-Settled Butter Futures Milk Class III Futures and Options Milk Class IV Futures and Options Cheese Nonfat Dry Milk Futures and Options Dry Whey Futures

15 Are You Doing Enough to Manage Your Risk? Protection Too Little or Too Late?

16 Corn & Wheat Volatility February 2000 September

17 Soybean Complex Volatility February 2000 September

18 Market Risk Summary Accept It Don t Fear It RISK Manage It Conquer it If you don t manage risk, you are assuming risk If you are assuming risk, you are speculating!!!

19 Types of Market Risk Global Grain Price CME Group Futures Your Local Cash Grain Basis Higher Stronger No change No change Lower Weaker

20 Review of Agricultural Futures & Hedging

21 PROTECTION Tim Andriesen, Managing Director Agricultural Products

22 What is a Futures Contract? Legally binding agreement to accept How many contracts result in physical delivery? delivery of or make delivery of a Is delivery on a futures contract a viable choice? standardized quantity and quality Do futures contracts replace cash contracts? of a commodity to a standardized place in a standardized time period for a price discovered in an organized futures exchange. Why is the delivery requirement necessary? Is there only one contract size available? Does this match up with physical production? Can any seller of futures deliver on the contract?

23 CBOT Wheat Futures (Soft Red Winter) Contract Specifications Size: 5,000 bushels (136 metric tons) Also mini-sized 1,000 bu (27 mt) Pricing unit: cents/bushel Tick size: 1/4 cent/bushel ($12.50 per contract) Ticker symbol: Open auction (W) and Globex Electronic (ZW) Daily price limit: $0.60/bushel Expandable to $0.90 and $1.35 Contract months: Jul(N), Sep(U), Dec(Z), Mar(H), May(K), Quality: #2 Soft Red Winter Trading hours: (Chicago time) Electronic: Open-auction: 7:00 p.m. 7:45 a.m. and 8:30 a.m. 1:15pm Sunday evening thru Friday afternoon 8:30 a.m. 1:15 p.m. Monday thru Friday Note: Mini-sized Wheat closes at 1:45 p.m. 23

24 Terminology Spot Basis Long Short Offset Delivery Margin Market price How many spot markets exist in the world? How many basis numbers should you follow? Are there more long or short positions? Does market liquidity impact an offset? Which party can initiate delivery on a futures contract? Is margin money a cost of trading? If you request ask for information on July 2014 Wheat, how many numbers should the broker provide.

25 Types of Traders It s All About Their Market Opinions Cash Market Cash Market Hedger Your Business Speculator Risk Liquidity Risk Liquidity Speculators provide what hedgers need!

26 Hedger s Profitability Revenue - Costs Profitability* *Futures & Options are used to protect a firm s profitability

27 Hedging with Futures

28 Basis The Key to Hedging Cash Price Futures Price Basis

29 Grain & Oilseed Basis Components Transportation Storage Quality Processing Margin & Handling World & Local Factors

30 Basis Movement +.30 Strengthen Cash Gains Relative* to Futures More positive or Less negative Benefits Short Hedgers *Basis can strengthen or weaken regardless of the price direction Weaken Cash Declines Relative* to Futures Less positive or More negative Benefits Long Hedgers

31 Price Risk Management Is there more than one way to skin a cat? Your Local Cash Market Futures Market

32 Hedging Mechanics FACT: Most Cash Markets & Futures Markets move up and down together HEDGING POSITIONS: Opposite positions in Cash Market and Futures Market HEDGING RESULTS: Loss in one market is offset by a gain in the other market Regardless of price direction, the result is the same!

33 Long Hedge

34 Long Futures Hedge Initiation of a long (buy) position in futures which is a temporary substitute for the eventual purchase of a commodity in your local market. Benefits from weakening basis over time

35 Long Hedger s Initial Positions Cash Market Short Futures Market Long Basis Short

36 Long KCBT Wheat Hedge Example #1 - Rising Market Nov12 CASH FUTURES BASIS Cash $7.90/bu. (information only) Long $7.50/bu..40 Over Jun15 Buy $8.70/bu. Sell $8.30/bu..40 Over.80/bu Gain No change Buy cash wheat $ 8.70/bu. Futures gain -.80/bu. Net Purchase Price $ 7.90/bu. = $290.28/m.t. 36

37 Long KCBT Wheat Hedge Example #2 - Falling Market Nov12 CASH FUTURES BASIS Cash $7.90/bu. (information only) Long $7.50/bu..40 Over Jun15 Buy $7.60/bu. Sell $7.20/bu..40 Over $.30/bu. Loss No change Buy cash wheat $ 7.60/bu. Futures loss /bu. Net Purchase Price $ 7.90/bu. = $290.28/m.t. 37

38 Long KCBT Wheat Hedge Example #3 - Rising Market with Weaker Basis Nov12 CASH FUTURES BASIS Cash $7.90/bu. (information only) Long $7.50/bu..40 Over Jun15 Buy $8.65/bu. Sell $8.40/bu..25 Over.90/bu. Gain.15 Basis Gain Buy cash wheat $ 8.65/bu. Futures gain -.90/bu. Net Purchase Price $ 7.75/bu. = $284.76/m.t. 38

39 Correlation Effective Hedge Liquidity

40 Summary of Risk Management Simply stated: It is all about your BOTTOM LINE Protecting and/or Improving YOUR LOCAL CASH MARKET POSITION

41 Review of Agricultural Options

42 OPPORTUNITY Tim Andriesen, Managing Director Agricultural Products

43 Options Contract between two parties that conveys a RIGHT but not an obligation to buy or sell a specific commodity at a specific price within a specific time period for a premium.

44 Futures Versus Options Risk Management Alternatives Futures Obligations Options Rights 44

45 Wheat Options Contract Specifications Underlying 5,000 Bushel Wheat futures contract Standard option: Mar, May, Jul, Sep, Dec Serial (all other months) Short-Dated New Crop Options (launch date: Sept 4, 2012) Tick Size 1/8 Cent/Bu ($6.25/contract) Strike Price Interval 5 cents (first two months) 10 cents (all other months)

46 Corn Options Contract Specifications Underlying 5,000 Bushel Corn futures contract Standard option: Mar, May, Jul, Sep, Dec Serial (all other months) Weekly Short-Dated New Crop Options (launched June 4, 2012) Tick Size 1/8 Cent/Bu ($6.25/contract) Strike Price Interval 5 cents (first two months) 10 cents (all other months)

47 Types of Options CALLS Contains the right to BUY PUTS Contains the right to SELL

48 Options Positions Call Option Buyer of call has rights to buy futures Seller of call has obligation to sell futures Long call and short call are offsetting positions Call Buyer Receives Rights (Buy Futures) CALL OPTIONS Call Seller Fulfills Rights (Sell Futures) 48

49 Options Positions Put Option Buyer of put has rights to sell futures Seller of put has obligation to buy futures Long put and short put are offsetting positions Put Buyer Receives Rights (Sell Futures) PUT OPTIONS Put Seller Fulfills Rights (Buy Futures) 49

50 Option Components Buyer holder Seller writer or grantor Underlying Commodity a futures contract Strike Price exercise price Expiration Date rights expire Premium price, cost, or value of rights 50

51 Option Quiz 1. What is the main difference between a futures and an option contract? 2. Do both parties in an option transaction receive rights? 3. Does a commodity option give the right to buy physical products? 4. What differentiates one option from another? 5. What guarantees the performance of a right? 6. Is the call option an opposite position to put option position? 51

52 Option Quiz 7. Who gets the rights and who is obligated to fulfill the rights? 8. What can happen to an option after it is initially traded? 9. Do option buyers have to maintain a margin account? 10. What is the profit/loss potential for a buyer of a commodity option? 11. What is the profit/loss potential for a seller of a commodity option? 12. Does the premium fluctuate during the life of the option? 52

53 Option Pricing.Difficult?

54 Black-Scholes Option Pricing Model Call Option Formula where: 54

55 Primary Option Pricing Concepts When Buying Options Pay Premium When Selling Options Receive Premium 55

56 Premium Components Premium Intrinsic Value Time Value

57 Time Value Curve Time Value Decreases at an increasing rate Time value is zero at option expiration Time value Cents/bushel Days to expiration 0 57

58 What Happens to Options Exercise 58

59 Other Types of Options

60 Serial Options Weekly Options Short Dated New Crop Options Calendar Spread Options

61 Serial Options Lower cost - Less time value 3 serials at a time Life span about 90 days American Exercise into nearby Futures Ideal for specific targeted time periods Available in every month not in the standard cycle

62 Weekly Options Lower cost - Less time value Life span about 28 days 3 weeklies at a time American Exercise into nearby Futures Ideal short-term hedges USDA reports

63 Short-dated New Crop Options Early expiring new crop options Underlying Futures: Dec Corn, Nov Soybeans & July Wheat Less time value less cost Impacted by same fundamentals as standard options Effective Hedging Tool and Trading Opportunities Useful for seasonal hedges planting & growing Around USDA reports Potential arbitrage opportunities CSO and outrights

64 Short-Dated New Crop (SDNC) Options Listing Cycle Underlying Futures December Corn November Soybeans Corn & Soybean SDNC Options March Contract (Expires in February) May Contract (Expires in April) July Contract (Expires in June) September Contract (Expires in August) Aug > Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec New Crop Months are December Corn and November Soybeans Available for trading beginning first business day following September Options expiration (Aug 26, 2013) 64

65 Calendar Spread Options Option on a futures Spread Corn, Wheat, Soybeans, SoyMeal & SoyOil Full year of consecutive spreads Old crop New Crop & reversal New crop New Crop Efficient Hedge for Inventory Value & Spread Risk Sensitive only to the spread value and volatility Ideal for the Roll Precise hedges - 1 cent versus 5 cent strikes

66 Calendar Spread Options (CSO) CSO an option on the price spread between futures contract months. Spread calculation: Nearby futures minus Deferred futures European Style Exercise Grain CSO Corn Wheat Soybeans Soybean Oil Soybean Meal 67

67 Risk Management Strategies Using Futures and Options

68 VARIETY Tim Andriesen, Managing Director Agricultural Products

69 Buy Side Risk Management Strategies

70 Buying Strategies Long Futures Long Call Combo: Long Call & Short Put Cash Forward Purchase Basis Contract Spot Purchase

71 Long KCBT Wheat Futures Example: Long July 7.50 (expected basis: ) If July Cash Futures Buying Wheat + Basis = Price -P/+L = Price _ = L = = = = 9.40 P = Would a change in the July Wheat futures price ever affect this strategy? 2. What would affect the net buying price? 3. If you only hedged 50%, which of the three scenarios would work out best? 4. Based on the answer to #3, what would be the effective buying price? 72

72 Long KCBT Wheat Futures Example: Long July 7.50 (expected basis: ) If July Cash Futures Buying Wheat + Basis = Price -P/+L = Price _ = L = = = = P = Would a change in the July Wheat futures price ever affect this strategy? 2. What would affect the net buying price? 3. If you only hedged 50%, which of the three scenarios would work out best? 4. Based on the answer to #3, what would be the effective buying price? 73

73 Buy Side Strategies Long Call Long Call (Buy Call) Establishes a maximum purchase price level Protected against higher prices at time of cash purchase Can benefit from lower prices at time of cash purchase Must pay the premium/cost of the option Weaker basis will improve (lower) purchase price at time of cash purchase Stronger basis will increase purchase price at time of cash purchase Equation: Maximum Purchase Price = Call Strike price + Basis + Premium 74

74 Long $7.50 $0.65 (premium cost) KCBT Wheat $7.50 Unlimited Upside Protection Maximum Purchase Price = $ Call Strike = $7.50 = Futures Full Downside Opportunity 5.50

75 Long KCBT Wheat Call Example: Long July 7.50 $0.65 (expected basis: +.40) If July Cash Call Buying Wheat + Basis = Price -P/+L = Price _ = L = = +.65L = = P = 1. What would happen to the buying price if the July Wheat futures moved higher than $9.00? 2. What would happen to the buying price if the July Wheat futures moved lower than $6.00? 3. What factors could impact the buying price and how? 4. Are there other strategies to achieve similar benefits as the long call? 5. If this strategy is too expensive, how can you alter it? 76

76 Long KCBT Wheat Call Example: Long July 7.50 $0.65 (expected basis: +.40) If July Cash Call Buying Wheat + Basis = Price -P/+L = Price _ = L = = L = = P = What would happen to the buying price if the July Wheat futures moved higher than $9.00? 2. What would happen to the buying price if the July Wheat futures moved lower than $6.00? 3. What factors could impact the buying price and how? 4. Are there other strategies to achieve similar benefits as the long call? 5. If this strategy is too expensive, how can you alter it? 77

77 Buy Side Strategies Long Call & Short Put Long Call & Short Put (Buy a Call and Sell a Put) Establishes a purchase price range Usually select an out-of-the-money Put option Protection against higher prices but at a lower cost Limits your opportunity for lower prices Weaker basis will improve (lower) purchase price at time of cash purchase Stronger basis will increase purchase price at time of cash purchase Equation Maximum purchase price = Call strike price + call premium put premium + basis Minimum purchase price = Put strike price + call premium put premium + basis 78

78 Buying Range Long $7.50 Call (cost $0.65) and Short $6.50 Put (credit $0.15) Net Cost $0.50 KCBT Wheat $7.50 Unlimited Upside Protection 9.50 Maximum Price = $ Call Strike = $7.50 = Futures Price 7.50 Minimum Price = $ Limited Downside Opportunity 5.50

79 Long KCBT Wheat Call & Short Wheat Put Example: Long 7.50 July $0.65 (expected basis: +.40) Short 6.50 July $0.15 If July Cash Call Put Buying Wheat + Basis = Price -P/+L -P/+L = Price = +.65L +.35L = = L.15P = = P P = What determines the buying price range and how can you alter the range? 2. What factors in this example could affect the buying price? 3. What is the best way to calculate an expected basis level? 4. Is the objective of all risk management strategies to make money in the futures industry? 80

80 Long KCBT Wheat Call & Short Wheat Put Example: Long 7.50 July $0.65 (expected basis: +.40) Short 6.50 July $0.15 If July Cash Call Put Buying Wheat + Basis = Price -P/+L -P/+L = Price = L +.35L = = L.15P = = P.15P = What determines the buying price range and how can you alter the range? 2. What factors in this example could affect the buying price? 3. What is the best way to calculate an expected basis level? 4. Is the objective of all risk management strategies to make money in the futures industry? 81

81 Buy Side Strategies Cash Forward Contract Cash Forward Contract (long term purchase agreement) Establishes a flat price in advance of actual cash purchase Price level and basis level are locked-in Price level is derived from futures price Can t benefit from weaker basis at time of actual cash purchase Equation Locked-in Futures price + Locked-in Cash Forward Basis Example and Note: $7.50/bushel and forward contract basis over July futures Cash Forward 8.25/bushel Note: A change in the futures level and/or the basis level at delivery time will not affect the purchase price 82

82 Buy Side Strategies Basis Contract Basis Contract Establishes (locks-in) a basis level in advance of actual cash purchase Only the basis level is locked-in Price level is derived from a futures price at a time the buyer chooses but must occur before the specific futures contract expires Can t benefit from weaker basis at time of actual cash purchase Subject to risk of higher price levels Equation Specified futures contract price at time of pricing + locked-in basis Example and note: Basis Contract: $0.70 over July futures Note: Any change in the basis prior to contract expiration will not impact the purchase price but a change in the futures price will impact this strategy 83

83 Buy Side Strategies Spot (Cash) Purchase Cash (local supplier quote) Flat spot price quote at time of current physical delivery Derived from futures price and includes current local basis Subject to price and basis level risk at time of actual cash purchase Equation: Futures Price + Basis at delivery time = Spot Price 84

84 Buy Side Strategies Comparative Analysis (assume actual basis: +.40) If July Long Long (L) Call Cash +.70 Basis Spot Wheat Futures Call (S) Put Forward Contract Purchase What strategy provides the best result when the market moves Lower? Higher? Remains the Same? 2. What adjustments to the results must a customer consider to compare strategies as apples to apples? 3. What are some of the key benefits of the futures/option strategies compared to the cash strategies? 4. What do most of all these strategies in the futures, options and cash market have in common? 5. Is there another market that could help customers manage price risk? If so, what is it? 85

85 Structured Customer Contracts: Maximum Purchase Price

86 Buyer Maximum Price Contract Long Term Purchase Contract + Put Option Incorporates features of a Forward Purchase Contract & a Long Put Option Buyer & Supplier sign a Maximum Price Contract Establishes a buy price level & basis level (same as a Forward Purchase Agreement) Delivery of specific grain/oilseed is mandatory (same as a Forward Contract) Supplier purchases a Put Option (buyer chooses) Supplier charges a service fee (brokerage plus additional service fee) Buyer chooses when to sell the put option (prior to option expiration) Buyer Maximum Buying Price Equation: Long Term Purchase Price + Put Premium Paid + Supplier Service Fee 87

87 Buyer Maximum Price Contract - Example Forward Contract + Put Option (July $7.00) Supplier & Buyer Agree to a Maximum Price Contract Forward Contract Price 7.30 (July basis) Put Premium Paid (premium paid) + Supplier Service Fee (1 cent R/T brokerage & 1 cent service) Buyer Maximum Buying Price $7.87 If July Futures fall to $5.00 If July Futures rallies to $9.00 Wheat delivered for $7.87 Wheat delivered for $7.87 Sell 6.80 Put for Put expired worthless $6.07* Buyer Net Price $7.87* *Excludes potential for remaining time value 88

88 Buyer Maximum Price Contract Basis Contract + Call Option Incorporates features of a Basis Contract & a Long Call Option Buyer & Supplier sign a Maximum Price Contract Establishes basis level (same as a Basis contract) Delivery of specific grain/oilseed is mandatory (same as a Basis Contract) Supplier purchases a Call Option buyer chooses Supplier charges a service fee (brokerage plus additional service fee) Buyer chooses when to sell the Call option (prior to option expiration) Buyer Maximum Buying Price Equation: Call Strike Price + Basis + Call Premium Paid + Supplier Service Fee 89

89 Example: Buyer Maximum Price Contract Firm Basis Contract + Call Option (Note July $7.00) Supplier & Buyer Agree to a Maximum Price Contract 720 July Wheat Call $7.20 (call strike price) July Basis Contract July Call Premium Paid (premium paid) + Supplier Service Fee (1 cent R/T brokerage & 1 cent service) Buyer Maximum Buying Price $8.06 If July Futures fall to $5.00 If July Futures rallies to $9.00 Wheat delivered for $5.30 Wheat delivered for $9.30 Call expires worthless + 0 Call Cost & Service Call Cost & Service Sell 7.20 Call for $5.86* Buyer Net Price $8.06* *Excludes potential for remaining time value 90

90 Intermediate Level Price Risk Management Strategies Buy Side

91 Other Buy Side Strategies 1. Short Put Option 2. Long Call Option Spread 3. Long Call Option Spread and Short a Put Option 4. Synthetic Long Futures 5. Synthetic Long Call Option 92

92 Buy Side Strategies Short Put Option Initial Futures Market Position: Short (sell) Put option Initial Cash Market (and Basis) Position: Short Margin Requirements: Yes Advantages: Improves (lowers) net buying price in stable (unchanging) markets Provides limited protection against higher price levels at time of physical (cash) purchase Limited opportunity for lower price levels at time of cash purchase Weaker basis at time of cash purchase will lower the net buying price; i.e. basis opportunity Financial integrity of your option position is ensured by CME Clearing Disadvantages: Only limited upside protection (premium received for selling the Put) A Minimum or Floor Buying price level is established Short Put option position could be exercised on at any time during the life of the option Stronger basis at time of physical purchase will increase your buying price; i.e., basis risk Must maintain a margin account Must consider transaction costs (brokerage commissions and interest costs on margin) Expected Net Minimum (Floor) Buying Price = Put Strike Price - Premium Received + Expected Basis 93

93 Buy Side Strategies Long Call Option Spread Initial Futures Market Position: Long (buy) Call option AND Short (sell) higher strike Call Initial Cash Market (and Basis) Position: Short Margin Requirements: No (provided the short Call position has a higher strike price) Advantages: Provides protection against higher price levels but only up to the higher Call strike price level Cost of the long Call strategy is reduced by the premium received from the short Call option position Can benefit from lower price levels at time of cash purchase Weaker basis at time of cash purchase will improve (lower) your net buying price; i.e. basis opportunity Financial integrity of your option positions are ensured by CME Clearing Flexible strategy; allows offsetting of positions at any time Disadvantages: Must pay the difference between the lower Call strike premium paid and the higher Call strike premium received Short Call position could be exercised on at any time during the life of the option Stronger basis at time of physical purchase will increase your net buying price; i.e., basis risk Must consider transaction costs (brokerage commissions on options) 94

94 Buy Side Strategies Long Call Option Spread and Short Put Option Initial Futures Market Position: Long a Call, Short a higher strike Call and Short a Put Initial Cash Market (and Basis) Position: Short Margin Requirements: Yes (on the short Put position) Advantages: Provides protection against higher price levels but only up to the higher Call strike price level Cost of the long Call is reduced by the premium received from the short Call and short Put option positions Can benefit from lower price levels down to the short Put strike price level at the time of cash purchase Weaker basis at time of cash purchase will improve (lower) your net buying price; i.e. basis opportunity Financial integrity of your option positions are ensured by CME Clearing Flexible strategy; allows offsetting of positions at any time Disadvantages: Must pay the difference between the lower Call strike premium paid and the higher Call strike premium received Short Call and/or short Put positions could be exercised on at any time during the life of the option May have margin requirements on short option position(s) Stronger basis at time of physical purchase will increase your net buying price; i.e., basis risk Must consider transaction costs (brokerage commissions on calls and put sand interest on short Put margin) 95

95 Synthetic Long Futures Long Call & Short Put Profit Synthetic Long Futures Short Put Breakeven Long Call Loss

96 Synthetic Long Call Long Futures & Long Put Profit Long Futures Breakeven Synthetic Long Call Long Put Loss

97 Summary & Benefits of CME Group

98 Summary of Trading Opportunities Depending on Commercial Firm s risk reward profile, you should be able to find a strategy suitable for you and/or your customers. Seasonal Volatility Related Bullish or Bearish Outrights Spreads Futures, Options, Swaps or Combinations 99

99 Trading Opportunities Seasonal Bearish Bullish Trading Opportunities Outrights Spreads Volatility Based 100

100 Benefits of CME Group Options Variety of Ag Products Flexible Uses Liquidity & Transparency Regulation & Financial Integrity Choice of Trading Platforms Customer Service

101 Are Futures & Options Difficult? Nah, with a little practice, it s all relative!

102 Customer Service

103 For More Information on CME Group Commodity Products Executive Director Ag & Alt Investment Products London Based Director CD&S - Commodity London Based Director Commodity Product Marketing Chicago Based Jeffry.Kuijpers@cmegroup.com Lisa.Kallal@cmegroup.com Richard.Jelinek@cmegroup.com Jeffry Kuijpers Lisa Kallal Richard Jelinek

104 Appendix

105 Traditional Sell Side Option Strategies

106 Selling Strategies Short Futures Long Put Combo: Long Put & Short Call Cash Forward Contract Basis Contract Cash Contract

107 Sell Side Strategies Short Futures Short Futures (Sell futures) Protects against falling prices Establishes a selling price Protects an inventory value Can t benefit from higher price Stronger basis will (improve) increase selling purchase price at time of cash sale Weaker basis will lower selling price at time of cash sale Equation: Futures price + Expected Basis = Expected Selling Price or Short futures price = Protected Inventory Price 108

108 Unlimited Upside Protection Short CBOT Wheat $7.00/bushel 9.00 No Upside Opportunity Lock-in Price Level Lock-in Futures Price Level 7.00 Unlimited downside protection 5.00

109 Short CBOT Wheat Futures Example: Short July 7.00 (expected basis: ) If July Cash Futures Selling Wheat + Basis = Price +P/-L = Price _ = P = = = = L = Would a change in the July Wheat futures price ever affect this strategy? 2. What would affect the net selling price? 3. If you only hedged 50%, which of the three scenarios would work out best? 4. Based on the answer to #3, what would be the effective selling price? 110

110 Short CBOT Wheat Futures Example: Short July 7.00 (expected basis: ) If July Cash Futures Selling Wheat + Basis = Price +P/-L = Price _ = P = = = = L = Would a change in the July Wheat futures price ever affect this strategy? 2. What would affect the net selling price? 3. If you only hedged 50%, which of the three scenarios would work out best? 4. Based on the answer to #3, what would be the effective selling price? 111

111 Sell Side Strategies Long Put Long Put (Buy Put) Establishes a minimum or floor selling price level or (inventory value) Protects against lower price levels at time of cash sale or Protects against a drop in inventory value Benefits from higher prices or improved inventory value at cash sale Stronger basis will improve (increase) sale price at time of cash sale Weaker basis will lower sale price at time of cash sale Equation: Put Strike Price + Basis - Premium = Minimum Selling Price 112

112 Long $7.00 $0.80 (premium cost) CBOT Wheat Futures $ Unlimited Upside Opportunity 7.80 Put Strike = $ Minimum Price = $ Unlimited Protection 5.00

113 Long CBOT Wheat Put Example: Long July 7.00 $0.80 (expected basis: ) If July Cash Call Selling Wheat + Basis = Price +P/-L = Price _ = = =.80L = = L = 1. What would happen to the selling price if the July futures moved higher than $9.00? 2. What would happen to the selling price if the July futures moved lower than $5.00? 3. What factors could impact the selling price and how? 4. Are there other strategies to achieve similar benefits as the long put? 5. If this strategy is too expensive, how can you alter it? 114

114 Long CBOT Wheat Put Example: Long July 7.00 $0.80 (expected basis: ) If July Cash Call Selling Wheat + Basis = Price +P/-L = Price _ = P = = L = = L = What would happen to the selling price if the July futures moved higher than $9.00? 2. What would happen to the selling price if the July futures moved lower than $5.00? 3. What factors could impact the selling price and how? 4. Are there other strategies to achieve similar benefits as the long put? 5. If this strategy is too expensive, how can you alter it? 115

115 Sell Side Strategies Long Put & Short Call Long Put & Short Call (Buy a Put and sell a Call) Establishes a selling price range (inventory level) Usually select an out-of-the-money call option Protects against lower prices at a lower cost Protects against drop in inventory value at a lower cost Limited opportunity for higher prices Equation Put strike price + call premium put premium + basis = minimum selling price Call strike price + call premium put premium + basis = maximum selling price 116

116 Long $7.00 $0.80 Short $8.00 $0.30 (Net Cost $0.50) CBOT Wheat $ Limited Upside Opportunity to $ Selling Price or Inventory Range Put Strike = $7.00 = Futures Price 7.00 Minimum Price = $ Unlimited Downside Protection 5.00

117 Long CBOT Wheat Put & Short Wheat Call Example: Long 7.00 July $0.80 (expected basis: -.40) Short 8.00 July $0.30 If July Cash Put Call Selling Wheat + Basis = Price +P/-L +P/-L = Price = P P = =.80L P = = P = What would be the effective selling price if July Wheat futures declined below 5.00? Above 9.00? 2.What determines the selling price range and how can you alter the range? 3.What factors in this example could affect the selling price? 4.Is the objective of all risk management strategies to make money in the futures industry? 118

118 Long CBOT Wheat Put & Short Wheat Call Example: Long 7.00 July $0.80 (expected basis: -.40) Short 8.00 July $0.30 If July Cash Put Call Selling Wheat + Basis = Price +P/-L +P/-L = Price = P P = = L P = = L P = What would be the effective selling price if July Wheat futures declined below 5.00? Above 9.00? 2.What determines the selling price range and how can you alter the range? 3.What factors in this example could affect the selling price? 4.Is the objective of all risk management strategies to make money in the futures industry? 119

119 Sell Side Strategies Cash Forward Contract Cash Forward Contract (long term purchase agreement) Establishes a flat price in advance of actual cash sale Price level and basis level are locked-in Price level is derived from futures price Can t benefit from stronger basis at time of actual cash sale Equation Locked-in Futures price + Locked-in Cash Forward Basis Example and Note: $7.00/bushel and forward contract basis under July futures Cash Forward 6.45/bushel Note: A change in the futures level and/or the basis level at delivery time will not affect the selling price 120

120 Sell Side Strategies Basis Contract Basis Contract Establishes (locks-in) a basis level in advance of actual cash sale Only the basis level is locked-in Price level is derived from a futures price at a time the seller chooses but must occur before the specific futures contract expires Can t benefit from stronger basis at time of actual cash sale Subject to risk of lower price levels Equation Specified futures contract price at time of pricing + locked-in basis Example and note: Basis Contract: $0.55 over July futures Note: Any change in the basis prior to contract expiration will not impact the sale price but a change in the futures price will impact this strategy 121

121 Sell Side Strategies Spot (Cash) Sale Cash (local elevator quote) Flat spot price quote at time of current physical delivery Derived from futures price and includes current local basis Subject to price and basis level risk at time of actual cash sale Equation: Futures Price + Basis at delivery time = Spot Price 122

122 Sell Side Strategies Comparative Analysis (assume actual basis: -.40) If July Short Long (L) Put Cash Basis Spot Wheat Futures Put (S) Call Fwd (-.55) Sale What strategy provides the best result when the market moves Lower? Higher? Remains the Same? 2. What adjustments to the results must a customer consider to compare strategies as apples to apples? 3. What are some of the key benefits of the futures/option strategies compared to the cash strategies? 4. What do most of all these strategies in the futures, options and cash market have in common? 5. Is there another market that could help customers manage price risk? If so, what is it? 123

123 Questions?

124 Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of a contract s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade. The Globe Logo, CME, Chicago Mercantile Exchange, and Globex are trademarks of Chicago Mercantile Exchange Inc. CBOT and the Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago. NYMEX, New York Mercantile Exchange, and ClearPort are trademarks of New York Mercantile Exchange, Inc. COMEX is a trademark of Commodity Exchange, Inc. CME Group is a trademark of CME Group Inc. KCBT and Kansas City Board of Trade are trademarks of the Board of Trade of Kansas City, Missouri, Inc. All other trademarks are the property of their respective owners. The information within this presentation has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for any errors or omissions. Although every attempt has been made to ensure the accuracy of the information within this presentation, CME Group assumes no responsibility for any errors or omissions. Additionally, all examples in this presentation are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. All matters pertaining to rules and specifications herein are made subject to and are superseded by official CME, CBOT, NYMEX, KCBT and CME Group rules. Current rules should be consulted in all cases concerning contract specifications.