Friday, November 26, 2010

Corn Hedge Strategy?

Below is a trade/hedge strategy (perhaps speculative? it isn't a traditional hedge) that a producer might look at; it is out of the box
and even thought it may appear to be risk free it is anything but. One of the biggest mistakes in options is leverage and at times over leverage. The realization needs to be made that option trades are not the same as futures and the more legs to a trade the more complicated it can become. To really get a good crisp on how multi leg trades work watch or read on the Greeks of options; i.e. price work behind the mechanism.

Trade to re-own board plus get a little downside protection and do so for a net credit; this trade was done for 10-11 cents credit; I bought board; sold a 6.00 call (60 cents above where I own board at; i.e. covered call) and then added a ratio put spread to help give me a little protection. Very little risk on this play unless we go sideways to down a little or if we break hard as I own the board 3x at 4.80 or below; so losses can accelerate. If we see a fundamental change or we rise far enough where I can buy the sold puts back for very little that will be the plan. On the upside I might look at trading in and out of the long if I can buy breaks and sell against resistance or rallies.

Here is chart with the pink lines showing important areas.

Here is P L Graph; green line is at expiration; the thing this doesn't show is what the trade will be worth based on X move by X time period; which is why we see plenty of mistakes in options.

Below shows the Greeks; you can see this trade is presently acting just like 1 long future contract; but on a big break near expiration will act like 3 contracts long and will cap out at 6.00 or act like a neutral position; while a small break will allow it to act like a short position. Big risk is going to be long 3 contracts on a big break.

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