Commodity prices for corn, cotton, soybeans, and wheat are high, yet could go higher. Put options on agricultural commodity futures are an important risk management tool for producers in today’s environment. Buyers of put options pay a “premium” for the right, but not an obligation, to sell a commodity at a specified price on a future date. The premium price (cost) is based on five primary factors:

**Current futures price**of the underlying commodity.**Strike Price:**Price at which the buyer can exercise the right to sell the underlying futures contract.**Time to Expiration:**Number of days until the option expires.**Volatility:**The variation of a trading price of the commodity over time.**Interest Rate:**The risk-free interest rate that matches the time to expiration.

Scenario 1, depicted in Figure 1, simulates how these five factors impact the put option premium and provide price risk management for producers.

**Figure 1. ***Simulated Put Option Premiums – Various Strike Prices on Single Date***. **Author calculations.

On March 17, 2022, September 2022 Corn futures (CU22) were trading for $6.49 per bushel. The days to expiration are 162 days or 44.4% of a year. The volatility is 36.79% and the risk-free interest rate is 0.50%. An at-the-money (ATM) put option ($6.50) would be priced at $0.63 per bushel, while an out-of-the-money (OTM) put options ($6.40) would be $0.58 per bushel.

Scenario 2 (Figure 2) illustrates how the put premium changes over time, if the market price, volatility, and interest rate remain at the March 17, 2022, values.

**Figure 2. ***Simulated Put Option Premiums – Time Premium over Multiple Dates. *Author calculations.

The risk that futures prices, volatility, or interest rates could change diminishes as the days to expiration decreases. With less time there is less risk and premiums decrease. Scenario 2 shows the put premium dropping about $0.01 per bushel per week based on time.

Assume a producer buys a $6.50 September 2022 put option on March 17, 2022, for $0.63 per bushel. The producer will receive $6.50 if the option expires worthless on August 26, 2022. The effective price would be $5.87 after deducting the put option cost of $0.63 from the strike price of $6.50.

An effective price of $5.87 is not attractive when the current futures price is $6.49. But the buyer of a put option can sell his option before expiration and realize a higher effective price which makes buying puts a valuable risk management tool. Figure 3 illustrates how put option premiums change as time diminishes and futures prices fluctuate. The table maintains volatility and interest rates at the March 17^{th} levels.

On April 16^{th}, if September 2022 corn futures are still trading at $6.49, the producer could sell the put option for $0.57 and price his corn for $6.49 for a net price of $6.43 plus basis (Sell for $6.49 minus $0.63 cost to buy plus $0.57 for selling the put). If the price rallies to $6.79, the net option loss increases to $0.18 per bushel (Sold for $0.45 and bought for $0.63) but the net price increases to $6.61 per bushel (Sold for $6.79 less $0.18 net put premium cost). If the price drops to $6.19, the gain on the put premium is $0.09 (Sold for $0.72 and bought for $0.63) and the net price is $6.28 (Sold for $6.19 plus $0.09 net put premium gain)

**Figure 3. ***Simulated Put Option Premiums – Single Strike Price, Multiple Dates & Futures Prices. *Author calculations.

Buying put options provides buyers protection against lower prices. The premiums can be high, especially when volatility and time to expiration are high. But when used for short periods of time, the premiums can retain a significant portion of their value. Buying put options requires no margin deposits although the premium is paid when purchased. Put options are an important risk management tool for creating minimum price floors over short periods of time.

Mickey, Scott A. . “Using Put Options for Risk Management“. *Southern Ag Today* 2(14.1). March 28, 2022. Permalink