VOLATILITY: FRIEND OR ENEMY? YOU DECIDE!

Transcription

1 VOLATILITY: FRIEND OR ENEMY? YOU DECIDE! Jared Morgan INTL FCStone Financial Inc. FCM Division Kansas Farm Bureau -- Young Farmers & Ranchers Conference January 25-27, 2019 Manhattan, KS Part 1

2 DISCLOSURES The trading of derivatives such as futures, options, and over-the-counter (OTC) products or swaps may not be suitable for all investors. Derivatives trading involves substantial risk of loss, and you should fully understand those risks prior to trading. Past financial results are not necessarily indicative of future performance. All references to futures and options on futures trading are made solely on behalf of the FCM Division of INTL FCStone Financial Inc., a member of the National Futures Association ( NFA ) and registered with the U.S. Commodity Futures Trading Commission ( CFTC ) as a futures commission merchant. All references to and discussion of OTC products or swaps are made solely on behalf of INTL FCStone Markets, LLC ( IFM ), a member of the NFA and provisionally registered with the CFTC as a swap dealer. IFM s products are designed only for individuals or firms who qualify under CFTC rules as an Eligible Contract Participant ( ECP ) and who have been accepted as customers of IFM. This material should be construed as the solicitation of trading strategies and/or services provided by the FCM Division of INTL FCStone Financial Inc., or IFM, as noted in this presentation. Neither the FCM Division of INTL FCStone Financial Inc. nor IFM is responsible for any redistribution of this material by third parties or any trading decisions taken by persons not intended to view this material. Information contained herein was obtained from sources believed to be reliable, but is not guaranteed. These materials represent the opinions and viewpoints of the author, and do not necessarily reflect the opinions or viewpoints of the FCM Division of INTL FCStone Financial Inc. or IFM. All forecasting statements made within this material represent the opinions of the author unless otherwise noted. Factual information believed to reliable, was used to formulate these statements of opinion; but we cannot guarantee the accuracy and completeness of the information being relied upon. Accordingly, these statements do not necessarily reflect the viewpoints employed by the FCM Division of INTL FCStone Financial Inc. or IFM. All forecasts of market conditions are inherently subjective and speculative, and actual results and subsequent forecasts may vary significantly from these forecasts. No assurance or guarantee is made that these forecasts will be achieved. Any examples given are provided for illustrative purposes only, and no representation is being made that any person will or is likely to achieve profits or losses similar to those examples. Reproduction or use in any format without authorization is forbidden. Copyright All rights reserved.

3 VOLATILITY: THE EMOTIONAL ROLLER COASTER 3

4 Volatility Value representing the likelihood for change in: Pace of price movement Range of price movement Statistically generated value MEASURE OF RISK

5 How do you manage volatility (the measure of risk)? You can t! You have to manage the risk, not the volatility. 5

6 How do you manage volatility (the measure of risk)? Lets Change the way we think? You can t! You have to manage the risk, not the volatility. 6

7 Dealing with Normal Risk Exposure Buildings & Facilities How do we get Insurance? $$ Pay for it $$ Equipment Machinery and Trucks Insurance Training Service Plans Family and Employees Who pays for Insurance? Who likes paying for Insurance? Everyone Nobody Health and Safety WHY DO WE DO IT?? We have to, it is Essential

8 Essential for What?

9 Price Risk Incidence November 2018 Soybeans

10 -What are Opportunity Robbing Factors? YOURSELF!!

11 Volatility Monthly Historic Corn Volatility January 2009-January 2019 Source: Bloomberg What Happened in the Summer Months? Percent Volatility Volatility & Seasonality

12 60 Monthly Historic Volatility - KC Wheat January 2009-January 2019 Source: Bloomberg Do you see any similarities? Percent Volatility Percent Volatility Monthly Historic Volatility - Chicago Wheat January 2009-January 2019 Source: Bloomberg

13 Monthly Historic Volatility Chicago/KC Wheat January 2008-October 2018 Source: Bloomberg 90 CORRELATION Percent Volatility Chicago Wheat KC Wheat

14 Monthly Historic Volatility Heating Oil Diesel January 2009 January 2019 Source: Bloomberg Percent Volatility Percent Volatility Monthly Historic Volatility Gasoline RBOB January 2009-January 2019 Source: Bloomberg

15 Monthly Historic Volatility - Live Cattle Jan 2008-October Source: Bloomberg 40 Monthly Historic Volatility - Feeder Cattle Monthly Historic Volatility - Lean Hogs Jan 2008-October 2018 Source: Bloomberg Jan 2008-October 2018 Source: Bloomberg

16 60 50 Monthly Historic Volatility-Soybeans January 2009 January 2019 Source: Bloomberg Monthly Historic Volatility-Soybean Meal January 2009-January 2019 Source: Bloomberg Monthly Historic Volatility-Soybean Oil January 2009-January 2019 Source: Bloomberg

17 Volatility Example: KC Wheat Futures trading at $5.00 Compare Market Volatility: 20%, 30%, 40% Annualized Volatility 20% 30% 40% 68% Probability Price Range $ $6.00 $ $6.50 $ $7.00 At what volatility level is your risk the greatest? At what volatility level is your opportunity greatest? Note: 2 Standard Deviations is 95% Probability and 3 Standard Deviations is 99% probability

18 What Encourages Market Volatility? Uncertainty Price Basis

19 Basis Key to Successful Hedging Local Price Quote Global Benchmark Price Quote Local Cash Relative to Futures Cash Price Futures Price Basis How many basis levels should you track?

20 Basis Movement & Opportunity +30 Strengthen Cash Gains Relative* to Futures More positive or Less negative Benefits Short Hedgers Commodity Sellers Weaken Cash Declines Relative* to Futures Less positive or More negative Benefits Long Hedgers Commodity Buyers -30 *Basis can strengthen or weaken regardless of the price direction 20

21 Producers should be a Cash Minus Futures Seasonal Trends S tudent Volatility O f BASIS Location B asis Quality Seller wants Stronger Buyer wants Weaker

22 Types of Market Risk Global Higher No change Futures Price Lower

23 Types of Market Risk Local Stronger No change Cash Basis Weaker

24 Types of Market Risk Global Futures Price Higher No change Lower Local Cash Basis Stronger No change Weaker

25 Hedgers Tools To Manage Price Risk Futures Options ObligationsLocked-in Buying and Selling Levels Rights to Buy or Sell at Price levels with Opportunity for Improvement OTC* Cash Contracts Creative Financial Products with Pricing Flexibility Variety of Contracts with Physical Delivery Requirements *OTC products are designed only for individuals or firms who qualify under CFTC rules as an Eligible Contract Participant ( ECP ) and who have been accepted as customers of IFM.

26 Questions?

27 VOLATILITY: FRIEND OR ENEMY? YOU DECIDE! Jared Morgan INTL FCStone Financial Inc. FCM Division Kansas Farm Bureau -- Young Farmers & Ranchers Conference January 25-27, 2019 Manhattan, KS Part 2

28 DISCLOSURES The trading of derivatives such as futures, options, and over-the-counter (OTC) products or swaps may not be suitable for all investors. Derivatives trading involves substantial risk of loss, and you should fully understand those risks prior to trading. Past financial results are not necessarily indicative of future performance. All references to futures and options on futures trading are made solely on behalf of the FCM Division of INTL FCStone Financial Inc., a member of the National Futures Association ( NFA ) and registered with the U.S. Commodity Futures Trading Commission ( CFTC ) as a futures commission merchant. All references to and discussion of OTC products or swaps are made solely on behalf of INTL FCStone Markets, LLC ( IFM ), a member of the NFA and provisionally registered with the CFTC as a swap dealer. IFM s products are designed only for individuals or firms who qualify under CFTC rules as an Eligible Contract Participant ( ECP ) and who have been accepted as customers of IFM. This material should be construed as the solicitation of trading strategies and/or services provided by the FCM Division of INTL FCStone Financial Inc., or IFM, as noted in this presentation. Neither the FCM Division of INTL FCStone Financial Inc. nor IFM is responsible for any redistribution of this material by third parties or any trading decisions taken by persons not intended to view this material. Information contained herein was obtained from sources believed to be reliable, but is not guaranteed. These materials represent the opinions and viewpoints of the author, and do not necessarily reflect the opinions or viewpoints of the FCM Division of INTL FCStone Financial Inc. or IFM. All forecasting statements made within this material represent the opinions of the author unless otherwise noted. Factual information believed to reliable, was used to formulate these statements of opinion; but we cannot guarantee the accuracy and completeness of the information being relied upon. Accordingly, these statements do not necessarily reflect the viewpoints employed by the FCM Division of INTL FCStone Financial Inc. or IFM. All forecasts of market conditions are inherently subjective and speculative, and actual results and subsequent forecasts may vary significantly from these forecasts. No assurance or guarantee is made that these forecasts will be achieved. Any examples given are provided for illustrative purposes only, and no representation is being made that any person will or is likely to achieve profits or losses similar to those examples. Reproduction or use in any format without authorization is forbidden. Copyright All rights reserved.

29 Volatility Value representing the likelihood for change in: Pace of price movement Range of price movement Statistically generated value MEASURE OF RISK

30 Volatility Example: KC Wheat Futures trading at $5.00 Compare Market Volatility: 20%, 30%, 40% Annualized Volatility 20% 30% 40% 68% Probability Price Range $ $6.00 $ $6.50 $ $7.00 At what volatility level is your risk the greatest? At what volatility level is your opportunity greatest? Note: 2 Standard Deviations is 95% Probability and 3 Standard Deviations is 99% probability

31 What Encourages Market Volatility? Uncertainty Price Basis

32 How do you manage volatility (the measure of risk)? You can t! You have to manage the risk, not the volatility. 32

33 How do you manage volatility (the measure of risk)? Lets Change the way we think? You can t! You have to manage the risk, not the volatility. 33

34 Hedgers Tools To Manage Price Risk Futures Options ObligationsLocked-in Buying and Selling Levels Rights to Buy or Sell at Price levels with Opportunity for Improvement OTC* Cash Contracts Creative Financial Products with Pricing Flexibility Variety of Contracts with Physical Delivery Requirements *OTC products are designed only for individuals or firms who qualify under CFTC rules as an Eligible Contract Participant ( ECP ) and who have been accepted as customers of IFM.

35 Where do Commodity Prices Come From? Wheat Corn Oilseeds Feeder Cattle Live Cattle Coffee & Cocoa Futures Natural Gas Flour Interest Rates & FX Gasoline & Diesel Lean Hogs Distillers Grain Milk

36 Economic Functions of Futures Price Discovery Futures Markets Risk Management

37 Price Discovery: Supply & Demand Prices are Discovered Prices are NOT set by the Exchange Closest form of perfect competition Two-way Price Impact Transparent Prices

38 True Hedge Consists of Two Parts Local Merchant Futures, Options or OTC Swaps

39 Hedge Concepts Fact: Most cash markets and futures markets move up and down together Not necessarily in equal amounts Relationship between a cash & a futures price: Correlation Hedge Positions Opposite positions in Cash market and Futures market Hedge Results Loss in one market is offset by a gain in the other market Regardless of price direction, the result is the same! The TRUE hedge result is the COMBINED RESULTS of the Cash and Risk Management position(s)

40 Futures Margin Performance Bond Required for all Buyers AND Sellers of Futures Funds deposited in your account to Guarantee your position Not a Down Payment Marked to Market Daily Quoted in Dollars per Contract Margin amounts vary by: Commodity Price Level Market Volatility Margin requirements are small relative to the contract value Provides Leverage

41 Short Hedger Mentality Test Nearby KC Wheat Prices Source: Bloomberg Where is the greatest potential for price risk for a KC Wheat Seller? Point A or B Futures ( /bu) A B

42 Short Hedge to Protect Production Value Initial Positions Cash Futures Basis Long Short Long

43 Short KC $5.30/bu Scenario #1: Falling Market & Basis Unchanged CASH FUTURES BASIS Jan 25 Cash Fwd. $4.90/bushel (information only) Short $5.30/bu (under) July 10 Sell $4.20/bu. Buy $4.60/bu (under) $0.70/bu. Gain No change Sell Wheat Futures gain Net Selling Price* $ 4.20/bu /bu. $ 4.90/bu. *Examples do not include commissions or fees and basis numbers are theoretical

44 Short KC $5.30/bu Scenario #2: Rising Market & Basis Unchanged CASH FUTURES BASIS Jan 25 Cash Fwd. $4.90/bushel (information only) Short $5.30/bu (under) July 10 Sell $5.30/bu. Buy $5.70/bu (under) $0.40/bu. Loss No change Sell Wheat Futures Loss Net Selling Price* $ 5.30/bu /bu. $ 4.90/bu. *Examples do not include commissions or fees and basis numbers are theoretical

45 Short KC $5.30/bu Scenario #3: Falling Market & Basis Strengthened CASH FUTURES BASIS Jan 25 Cash Fwd. $4.90/bushel (information only) Short $5.30/bu (under) July 10 Sell $4.75/bu. Buy $5.00/bu (under) $0.30/bu. Gain 0.15 Basis Gain Sell Wheat Futures gain Net Selling Price* $ 4.75/bu /bu. $ 5.05/bu. *Examples do not include commissions or fees and basis numbers are theoretical

46 Short July19 KC $5.30/bushel (Contract size = 5,000 bu) Educational Example only Examples do not include commissions and fees. No Upside Opportunity 7.30 Lock-in Price Level Locked-in Futures Price Level 5.30 Unlimited Downside Protection CME Group. All rights reserved.

47 Would You like to have Protection Against Negative Price Levels & Opportunity To Capture Better Price Levels

48 Are Options Difficult? Call Option Formula

49 Futures versus Options (Review) Futures Convey Obligations Options Convey Rights

50 Option Types CALL Contains the right to BUY PUT Contains the right to SELL

51 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

52 Premium Components Premium Intrinsic Value Time Value

53 Premium Components Premium Intrinsic Value Time Value Intrinsic Value Strike Price Futures Price

54 Premium Components Premium Intrinsic Value Time Value Time Value Time Volatility Interest Supply & Demand

55 Premium Components Premium Intrinsic Value Time Value Time Value Time Volatility Intrinsic Value Strike Price Futures Price Interest Supply & Demand

56 Time Value Curve Decreases at an increasing rate Time value is zero at option expiration Time value Cents/bushel Dollars/cwt. Cents/pound Days to expiration 0

57 What Can Happen to Options Offset Options Exercise (Option Buyer Only) Expire

58 Closing Out an Option Position Premium Intrinsic Value Time Value Offset Capture Entire Premium (Intrinsic and Time Value) Exercise Capture only the Intrinsic Value (Forfeit the Time Value) Expiration Option value is Always ZERO at Expiration Don t ever forget about your option positions Recovered Time Value lowers the cost of the strategy

59 Long Put

60 Producer Sell Strategy Long Put Establishes a minimum sale price level Protected against lower price levels at time of cash sale Can benefit from higher price levels at time of cash sale Costs of this strategy Must pay the option premium at the time of the option purchase No margin requirements Brokerage commission Basis Impact at time of cash sale Stronger basis will improve (raise) sale price Weaker basis will decrease sale price Equation: Expected Minimum Sale Price = Put Strike price + Expected Basis - Premium

61 Long $5.50 July19 $0.35 July KC Wheat trading at $5.50 Educational Example only Examples do not include commissions and fees. Full Upside Opportunity 7.50 Upside Opportunity above $5.85 Call Strike = $5.50 Futures Minimum Sale Price=$ Unlimited Downside Protection CME Group. All rights reserved.

62 How Many Of You? LOVE to Lose Money?

63 Producers Use of Options Producer (Sale-Side) Application Current Market Conditions New-crop Soybean Sales November trading at $9.20/bushel $9.20 November Soybean Put Option $0.40/bushel Expected local basis for November Soybean Delivery: $-0.80 (under) WOW! That s Expensive. Strategy Long (buy) Nov19 Soybean $0.40/bushel Contract Notes: Soybean Contract Size 5,000 Bushels Soybean Futures trading ceases on the business day prior to the 15 th calendar day Soybean Options expire on the last Friday preceding at least 2 business days prior to the first business day of the corresponding futures contract month. *Theoretical examples do not include commissions and fees

64 Scenario One MARKET DROPS! Late October Market Conditions November Soybeans drop to $8.00/bushel $9.20 Nov19 Put is worth $1.20/bushel Your local Soybean Basis is -.80 November WELL! I guess that $0.40 wasn t so expensive Results: Offset your option hedge Sell Soybeans Locally for $7.20 per bushel Offset (sell back) $9.20 November Soybean Put and receive $1.20/bushel Profit on Long put Strategy = $0.80/bushel ($ $0.40 initial premium) Risk Management Result: $7.20 Cash Price + $0.80/bushel Put Gain *Theoretical examples do not include commissions and fees

65 Scenario Two MARKET SOARS! Late October Market Conditions November $9.20 Nov19 Soybean Put Option $0.00/bushel Your local Soybean basis at -$0.80 November OUCH! What happened to my premium? Results: Offset your option hedge Sell Soybeans Locally at $9.70/bushel ($ $0.80 Nov. basis) $9.20 Put expires worthless LOSS on Long Put Strategy = $0.40/bushel ($0.40 initial premium -.00 premium at expiry) Risk Management Result: ($9.70 Cash Price - $0.40/bushel Put Loss) *Theoretical examples do not include commissions and fees

66 Market Drops to $8.00/bushel Put PROFIT: $0.80/bushel Net Buying Price = ($7.20 cash + $0.80/bushel Put Profit) = $8.00/bushel Market Climbs to $10.50/bushel Put LOSS: $0.40/bushel Net Buying Price = ($9.70 cash - $0.40/bushel Put Loss) Now, how many of you LOVE TO LOSE MONEY? *Theoretical examples do not include commissions and fees $9.30/bushel

67 Summary of Option Pricing REMEMBER HEDGING CONCEPTS! An Option is only Part of Your Hedge Don t forget your Cash Market position Loss in Options is Offset by Improved Cash Market Position Option Premium loss may result in better NET position Cash Market Options

68 Volatility: Friend or Enemy? Volatility Summary Volatility is a Measure of Risk Increased Volatility = Increased Risk Increased Volatility = Increased Opportunity Volatility Does not Discriminate Creates Selling Opportunities Creates Buying Opportunities There are strategies to manage the risk/opportunity that volatility creates. YOU DECIDE! 68

69 For More Info & Assistance Contact INTL FCStone Financial Inc. Risk Management Associate INTL FCStone Financial Inc. FCM Division Telephone: (816) Education Specialist INTL FCStone Financial Inc. FCM Division Telephone: (312) Pete Fish Jared Morgan Thank You! 69