Tuesday, September 18, 2012

Re-owning on Paper..........from Country Hedging's Tregg Cronin

Below is good info from Country Hedging's Tregg Cronin on re-owning on paper for soybeans.

A lot of guys have expressed interest in taking advantage of high priced soybeans by selling them off the combine but wanting to re-own them on paper with calls, call spreads or some sort of option strategy.  Below I’ve outlined two such strategies using today’s settlements.

The first is a simple call diagonal spread.  It would consist of buying the January $17.00 call for $0.51 and selling the March $18.00 call for $0.38375 for a net cost of $0.12 5/8 or $630.  At expiration, this would have a break even at $17.12 5/8, or the bottom strike plus the cost of the strategy.  The maximum gain on this strategy is $0.87 or $4,350 per 1 lot contract.  The maximum loss, provided both options are exited at the same time, would be $0.12 5/8 or the cost of the strategy.  This particular example has differing expirations which would need to be managed if the desired outcome hasn’t been achieved by December 21st when the January $17.00 call expires.  The nice thing about this method is it has a favorable delta and gamma ratio, especially as we get closer to November/December.  It should be noted this strategy carries a bit of spread risk, in that if March soybeans were to all of the sudden rally sharply against January soybeans, it could put more value in the March call vs. the January call, making the position worth less.  I can go further into detail if needed.

The second strategy is  known as a 3-way because you buy 1 call, sell 1 call and sell 1 put.  In this example I used March options which would expire on February 22nd.  One could do a similar strategy for January if they wanted.  The particular strikes I used on this one was buying the $16.00 March call, selling the $18.00 March Call and selling the $15.00 March put for a net cost of $0.11 1/8 or $550 per 1 lot position.  This strategy would have a maximum gain of $1.88, or $9,443, at expiration if soybeans closed above $18.00 on February 22nd.  The maximum loss is a bit more tricky because of the short put.  You would actually be unprotected to the downside and would lose penny for penny below $15.00 should beans drop that far.  Obviously if soybeans were headed below $15.00, something big would have changed in our market place and the correct thing would be to exit the trade at a loss.  The nice thing about this strategy is it offers more upside for the tradeoff of downside vulnerability.

It really comes down to how much a guy wants to spend and what sort of risk profile he is willing to carry.  For what it’ worth, an at-the-money January $16.60 call would cost $0.67 ($3,350), and an at-the-money March $16.00 call would cost something around $0.94 ($4,700).  Owning strictly calls would limit one’s risk to the premium paid.  There are also serial options which offer a guy to calls without so much time premium and should therefore be cheaper, but we would also need the market to respond faster before our option expires.  If anyone has interest in these or other strategies, let me know and I can put together some charts which show the profit and loss graphs.  Thanks.

Tregg Cronin
Market Analyst
651-355-3723 fax
Country Hedging, Inc.
The Right Decisions for the Right Reasons

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