Risk Management 101, Buy When You Can, Not When you Need To

Organic corn prices are on the rise. Mid-West organic corn prices are testing resistance levels, despite robust inventories. The potential decline in organic corn imports from Turkey could lead to higher prices. The war in the Black Sea will make it difficult for importers to purchase corn and send it to the United States. If you believe organic corn prices are poised to move higher, you can consider hedging your exposure with financial derivatives.

How to Hedge Organic Corn Prices

One hedging idea that is helpful to envoke is to buy assets when you can, not when you need to. As organic corn prices test resistance levels, there is a chance that a breakout leads to a new range in organic corn prices. When markets are volatile, you can consider hedging using a call spread.

What is a Call Spread?

A financial derivative called a “call spread” is a combination of call options that allow you to protect against higher prices. A call spread is a risk management technique where you purchase a lower strike call and simultaneously sell a higher strike call option.

For example, as organic corn prices are about to break out, you might consider purchasing an $11 – $14 call spread. For a specific premium, you can protect yourself as organic corn rises above $11 per bushel and up to $14 per bushel.

The benefit of using a call spread is that the premium cost of purchasing a call spread is less than the premium required to buy a call option at the lower strike level. By selling a higher strike call that caps your gains, you reduce the premium you need to pay for the lower strike call.

How Are Options Traded

You can buy or sell options from an exchange or a market maker. If the product you want to hedge is not on a futures exchange, like organic corm, you can ask a market maker for a price and transact a call spread. These products are considered over-the-counter derivatives. These over-the-counter derivatives are usually settled against organic corn prices reported by reputable price reporting agencies.

The Bottom Line

The upshot is you should hedge your risk to organic corn prices before they break out. One of the best ways to protect yourself from rising organic corn prices is to trade a financial derivative. If you cannot trade the product you want on an exchange, you can work with a market maker to trade an over-the-counter call spread to protect yourself from higher organic corn prices.