Rain had stopped the work, and Lenny Pecha was sitting in his pickup, watching a steady shower fall. It gave the Oklahoma farmer and cattle producer a few minutes to talk about another uncertainty he manages: what his wheat and feeder cattle will bring when it is time to sell.
About 25 miles west of Enid, Pecha raises wheat and corn, runs stocker cattle and maintains a cow-calf operation. He forward-contracts grain and cattle when he can. But there is often a stretch between owning cattle and getting them contracted — time when a market downturn could cut into his return.
During that stretch, he buys put options to help protect against falling prices.
The Cash-Flow Dilemma
Cash flow matters, too. Using futures to protect a price can mean putting up additional capital as the market moves. Pecha says those demands make straight futures hedging difficult for his operation.
“The cool kids would do more straight hedging, but I just don’t have the funds to do that,” he says. “I utilize options because I can afford them.”
His approach reflects what many producers want: protection if prices fall, with some room to benefit if they rise.
Rethinking “Worthless” Expirations
But for producers who have bought options, watched them expire worthless and decided they were a waste of money, there may be more to consider. Buying a single put or call is one approach. Combining options can change the cost and the protection they provide.
Lauren Urbanczyk, principal and broker, and Jeremey Frost, broker, at Texas Hedge Risk Management say the first step is identifying what the operation needs to protect.
A farmer with grain to sell worries about falling prices. A rancher buying feed or replacement cattle worries about rising costs. Some operations face both concerns.
“There’s always going to be a cost or a risk associated with every transaction,” Urbanczyk says.
In practical terms, a purchased put helps protect against falling prices. A purchased call helps protect against rising prices. Buyers pay an upfront premium, and that protection lasts for a set period.
Neither locks in the price at the local elevator or sale barn. Local prices can move differently from the futures market, and premiums and other costs affect the final return.
Frost compares buying options to buying insurance. When the market offers a profitable price, protection can help keep that opportunity from slipping away before the commodity is sold.
“I just look at them as a tool to help enhance a farmer’s bottom line,” he says.
That means looking at the whole operation’s results. An option can expire worthless while the cattle or grain it protected sell for more money. The premium still costs something, but the lack of an option payout does not necessarily mean the marketing plan failed.
Spreads and Collars: Lowering Upfront Costs
Still, producers do not have to limit the conversation to buying protection and waiting for expiration.
Pecha also uses put spreads and sometimes sells calls to help pay for protection. Both approaches can lower the upfront expense, but each involves a trade-off.
With a put spread, a producer buys protection against falling prices and sells another put at a lower price level. The money received from that sale of the lower put helps offset the purchase cost of the total option strategy.
The result is protection within a price range. The producer can get downside protection on a price range, which may be a better fit depending on market conditions.
Another approach pairs a purchased put with a sold call. Selling the call helps pay for protection, but the producer gives up some benefit from a rising market.
Frost says selling calls can be a way “to get paid to have an offer out there.”
For a producer willing to sell at a particular price, that trade-off may fit the marketing plan. But it also creates an obligation, and the sold call can require additional margin as the market moves.
Lower upfront cost does not eliminate risk. Producers need to understand what they are agreeing to, how much grain or livestock supports the plan and what happens if production falls short.
Weighing Obligations and Margin Demands
The useful conversation with an adviser goes beyond asking which option to buy. It includes how much protection is needed, what it costs and what the operation can afford to give up in exchange.
Timing matters, too. Protection should cover the period before the expected sale. Existing contracts, production estimates and the price needed to cover costs all help shape the decision.
A purchased option generally limits the trading loss to the premium and transaction costs while it remains an option. Exercising it into a futures position changes those responsibilities, but also offers the potential to transfer that position to the end user. Strategies that include selling options may require additional deposits along the way.
For Pecha, those cash demands matter alongside the cost of borrowed money.
Urbanczyk says disappointment often begins when producers judge options only by whether they produce a payout.
“Was our objective to make money on the options or was it to protect the entire risk of the portfolio?” she asks. “When you understand how both buying and selling options can work within a desired directional strategy, you can get much higher satisfaction on options strategies than just simple long options that are likely to expire without netting a return.”
Stress-Testing Three Scenarios
Before choosing a strategy, producers can ask an adviser to walk through three possibilities: prices rise, prices fall or prices stay about the same. What would the commodity bring? What would the options add or subtract? Could the operation handle any additional cash demands?
That discussion can make the choices easier to understand — and reveal whether a different approach fits better than the one tried before.
Options can also leave room to benefit from a rally after grain is sold. A purchased call provides that opportunity, though its premium becomes another marketing expense.
“We’ve been able to help farmers who are over-contracted on their cash grain obligations through using long call strategies,” Frost says. “It feels good to be able to help a farmer work out of a tough production issue with options.”
For Pecha, options work alongside forward contracts and attention to available cash. They help bridge the time between having something to sell and getting a price established.
“My deals,” he says, “I try to keep them simple.”
