Hedging Against Falling Oats Prices using Oats Futures

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Contents

Hedging Against Falling Oats Prices using Oats Futures

Oats producers can hedge against falling oats price by taking up a position in the oats futures market.

Oats producers can employ what is known as a short hedge to lock in a future selling price for an ongoing production of oats that is only ready for sale sometime in the future.

To implement the short hedge, oats producers sell (short) enough oats futures contracts in the futures market to cover the quantity of oats to be produced.

Oats Futures Short Hedge Example

An oats farmer has just entered into a contract to sell 500,000 bushels of oats, to be delivered in 3 months’ time. The sale price is agreed by both parties to be based on the market price of oats on the day of delivery. At the time of signing the agreement, spot price for oats is USD 2.0900/bu while the price of oats futures for delivery in 3 months’ time is USD 2.1000/bu.

To lock in the selling price at USD 2.1000/bu, the oats farmer can enter a short position in an appropriate number of CBOT Oats futures contracts. With each CBOT Oats futures contract covering 5,000 bushels of oats, the oats farmer will be required to short 100 futures contracts.

The effect of putting in place the hedge should guarantee that the oats farmer will be able to sell the 500,000 bushels of oats at USD 2.1000/bu for a total amount of USD 1,050,000. Let’s see how this is achieved by looking at scenarios in which the price of oats makes a significant move either upwards or downwards by delivery date.

Scenario #1: Oats Spot Price Fell by 10% to USD 1.8810/bu on Delivery Date

As per the sales contract, the oats farmer will have to sell the oats at only USD 1.8810/bu, resulting in a net sales proceeds of USD 940,500.

By delivery date, the oats futures price will have converged with the oats spot price and will be equal to USD 1.8810/bu. As the short futures position was entered at USD 2.1000/bu, it will have gained USD 2.1000 – USD 1.8810 = USD 0.2190 per bushel. With 100 contracts covering a total of 500000 bushels, the total gain from the short futures position is USD 109,500

Together, the gain in the oats futures market and the amount realised from the sales contract will total USD 109,500 + USD 940,500 = USD 1,050,000. This amount is equivalent to selling 500,000 bushels of oats at USD 2.1000/bu.

Scenario #2: Oats Spot Price Rose by 10% to USD 2.2990/bu on Delivery Date

With the increase in oats price to USD 2.2990/bu, the oats producer will be able to sell the 500,000 bushels of oats for a higher net sales proceeds of USD 1,149,500.

However, as the short futures position was entered at a lower price of USD 2.1000/bu, it will have lost USD 2.2990 – USD 2.1000 = USD 0.1990 per bushel. With 100 contracts covering a total of 500,000 bushels of oats, the total loss from the short futures position is USD 99,500.

In the end, the higher sales proceeds is offset by the loss in the oats futures market, resulting in a net proceeds of USD 1,149,500 – USD 99,500 = USD 1,050,000. Again, this is the same amount that would be received by selling 500,000 bushels of oats at USD 2.1000/bu.

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Risk/Reward Tradeoff

As can be seen from the above examples, the downside of the short hedge is that the oats seller would have been better off without the hedge if the price of the commodity went up.

An alternative way of hedging against falling oats prices while still be able to benefit from a rise in oats price is to buy oats put options.

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As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

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Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

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Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

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Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Hedging Against Rising Oats Prices using Oats Futures

Businesses that need to buy significant quantities of oats can hedge against rising oats price by taking up a position in the oats futures market.

These companies can employ what is known as a long hedge to secure a purchase price for a supply of oats that they will require sometime in the future.

To implement the long hedge, enough oats futures are to be purchased to cover the quantity of oats required by the business operator.

Oats Futures Long Hedge Example

An oats mill will need to procure 500,000 bushels of oats in 3 months’ time. The prevailing spot price for oats is USD 2.0900/bu while the price of oats futures for delivery in 3 months’ time is USD 2.1000/bu. To hedge against a rise in oats price, the oats mill decided to lock in a future purchase price of USD 2.1000/bu by taking a long position in an appropriate number of CBOT Oats futures contracts. With each CBOT Oats futures contract covering 5000 bushels of oats, the oats mill will be required to go long 100 futures contracts to implement the hedge.

The effect of putting in place the hedge should guarantee that the oats mill will be able to purchase the 500,000 bushels of oats at USD 2.1000/bu for a total amount of USD 1,050,000. Let’s see how this is achieved by looking at scenarios in which the price of oats makes a significant move either upwards or downwards by delivery date.

Scenario #1: Oats Spot Price Rose by 10% to USD 2.2990/bu on Delivery Date

With the increase in oats price to USD 2.2990/bu, the oats mill will now have to pay USD 1,149,500 for the 500,000 bushels of oats. However, the increased purchase price will be offset by the gains in the futures market.

By delivery date, the oats futures price will have converged with the oats spot price and will be equal to USD 2.2990/bu. As the long futures position was entered at a lower price of USD 2.1000/bu, it will have gained USD 2.2990 – USD 2.1000 = USD 0.1990 per bushel. With 100 contracts covering a total of 500,000 bushels of oats, the total gain from the long futures position is USD 99,500.

In the end, the higher purchase price is offset by the gain in the oats futures market, resulting in a net payment amount of USD 1,149,500 – USD 99,500 = USD 1,050,000. This amount is equivalent to the amount payable when buying the 500,000 bushels of oats at USD 2.1000/bu.

Scenario #2: Oats Spot Price Fell by 10% to USD 1.8810/bu on Delivery Date

With the spot price having fallen to USD 1.8810/bu, the oats mill will only need to pay USD 940,500 for the oats. However, the loss in the futures market will offset any savings made.

Again, by delivery date, the oats futures price will have converged with the oats spot price and will be equal to USD 1.8810/bu. As the long futures position was entered at USD 2.1000/bu, it will have lost USD 2.1000 – USD 1.8810 = USD 0.2190 per bushel. With 100 contracts covering a total of 500,000 bushels, the total loss from the long futures position is USD 109,500

Ultimately, the savings realised from the reduced purchase price for the commodity will be offset by the loss in the oats futures market and the net amount payable will be USD 940,500 + USD 109,500 = USD 1,050,000. Once again, this amount is equivalent to buying 500,000 bushels of oats at USD 2.1000/bu.

Risk/Reward Tradeoff

As you can see from the above examples, the downside of the long hedge is that the oats buyer would have been better off without the hedge if the price of the commodity fell.

An alternative way of hedging against rising oats prices while still be able to benefit from a fall in oats price is to buy oats call options.

Learn More About Oats Futures & Options Trading

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Continue Reading.

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Oats Futures Trading Basics

Oats futures are standardized, exchange-traded contracts in which the contract buyer agrees to take delivery, from the seller, a specific quantity of oats (eg. 5000 bushels) at a predetermined price on a future delivery date.

Oats Futures Exchanges

You can trade Oats futures at Chicago Board of Trade (CBOT).

CBOT Oats futures prices are quoted in dollars and cents per bushel and are traded in lot sizes of 5000 bushels (86 metric tons).

Exchange & Product Name Symbol Contract Size Initial Margin
CBOT Oats Futures
(Price Quotes)
O 5000 bushels
(Full Contract Spec)
USD 1,350 (approx. 13%)
(Latest Margin Info)

Oats Futures Trading Basics

Consumers and producers of oats can manage oats price risk by purchasing and selling oats futures. Oats producers can employ a short hedge to lock in a selling price for the oats they produce while businesses that require oats can utilize a long hedge to secure a purchase price for the commodity they need.

Oats futures are also traded by speculators who assume the price risk that hedgers try to avoid in return for a chance to profit from favorable oats price movement. Speculators buy oats futures when they believe that oats prices will go up. Conversely, they will sell oats futures when they think that oats prices will fall.

Learn More About Oats Futures & Options Trading

You May Also Like

Continue Reading.

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Choice!
    Free Trading Education!
    Free Demo Account!
    Big Sign-Up Bonus!

  • Binomo
    Binomo

    Good Choice For Experienced Traders!!!

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