risk management for agricultural markets steven stasys +1 [email protected]...

Risk Management For Agricultural Markets

Steven Stasys

+1 312-648-3822 [email protected]

September, 10th 2015

© 2013 CME Group. All rights reserved. © 2015 CME Group. All rights reserved.

Market Risk Summary

2

RISK

Accept It

Don’t Fear It Manage It

Conquer it

If you don’t manage risk, you are assuming riskIf you are assuming risk, you are speculating!!!

© 2015 CME Group. All rights reserved.

Hedging: Price Risk Management

Cash Market FuturesMarket


Legally binding agreement to accept

delivery of or make delivery of a

standardized ______ and ______

of a commodity to a standardized _____

during a standardized ____ period for a _____

discovered in an organized futures exchange.

Futures Contract: Defined

quantity quality

place

time price


Price Discovery: Supply & Demand

• Prices are Discovered

• Prices are NOT set by the Exchange

• Closest form of “perfect competition”

• Two-way Price Impact

• Transparent Prices


Hedging Mechanics


Hedging With Futures - Notes

• Take advantage of current purchase and sale prices

• Protect against adverse prices

• Basis may improve purchase or sale price

• Assists with planning & budgets

• Protects inventory value

• Not tied to a specific buyer or supplier

• Financial integrity of CME Clearing


Basis: The Key Factor to Successful Hedging

Cash Price

Futures Price Basis


Basis: Concepts

BASIS

Cash minus

Futures

Locational

& Quality

Differences

Sellers want

Stronger

Buyers want

Weaker

Less Volatile

Seasonal & Historical

Trends


Basis: Components


Basis Movement

Strengthen

Cash Gains Relative* to Futures

More positive or

Less negative

Benefits Short Hedgers

*Basis can strengthen or weaken

regardless of the price direction

Weaken

Cash Declines Relative* to Futures

Less positive or

More negative

Benefits Long Hedgers

+.30

+.20

+.10

0

-.10

-.20

-.30


Basis Summary

• Cash price relative to a futures price

• Relatively less volatile than futures

• Seasonal & historical trends

• Tool for purchases and sales

• Buyers want basis to weaken over time

• Sellers want basis to strengthen over time

• Can have a negative or positive value


Types of Traders

Cash Market

Risk Liquidity

SpeculatorHedger

Risk Liquidity

Cash Market

Speculators provide what hedgers need!

LIQUIDITY

Potential Grain and Oilseed HedgersCash Market

FarmerOn-Farm

Use / StorageLivestock Operation

Elevator System

Feed Manufacturer Export Markets

Consumer

FUTURES MARKET

Energy Sector

Non-Food ItemProduction

Food/BeverageProcessors

Millers / Refiners

Retail / Wholesale

Seed Company

Restaurants Grocery Stores


What is Volatility?

Example: Wheat Futures at $6.00Compare Market Volatility: 20%, 30%, 50%

At what volatility level is your risk greatest?At what volatility level is your opportunity greatest?

Note: 2 Standard Deviations is 95% probability and 3 Standard Deviations = 99% probability

AnnualizedVolatility

68% ProbabilityPrice Range

20% $4.80 – $7.20

30% $4.20 – $7.80

40% $3.60 – $8.40

Products


Agricultural Commodity Product Complex

Grains and Oilseeds:•Corn Futures, Options & Swaps

•Wheat Corn Spread Options

•Mini-sized Corn Futures

•Ethanol Futures, Options and Swaps

•Oat Futures and Options

•Rough Rice Futures and Options

•Soybean Futures, Options & Swaps

•Mini-sized Soybean Futures

•Soybean Meal Futures and Options

•Soybean Oil Futures and Options

•Soybean Corn Price Ration Options

•Crude Palm Oil Futures

•Wheat Futures, Options & Swaps

•Mini-sized Wheat Futures

•Corn, Wheat, Soybeans, SoyOil, SoyMeal Calendar Spread Options

Livestock:

•Feeder Cattle Futures and Options

•Live Cattle Futures and Options

•Lean Hogs Futures and Options

•Live Cattle & Lean Hog Calendar Spread Options

Dairy Products:•Butter Futures and Options

•Butter Spot Call

•Cash-Settled Butter Futures

•Milk Class III Futures and Options

•Milk Class IV Futures and Options

•Cheese

•Nonfat Dry Milk Futures and Options

•Dry Whey Futures

Options


Primary Option Pricing Concepts

20

• When Buying Options – Pay Premium

• When Selling Options – Receive Premium

Contract between two parties that conveys a RIGHT but not an obligation to

buy or sell a specific commodity at a specific price within a specific time

period for a premium.


Types of Options

21

• Contains the right to BUYCALLS

• Contains the right to SELLPUTS

© 2013 CME Group. All rights reserved. © 2015 CME Group. All rights reserved. 22

Option Expires Option Exercise Option Offset

Options expire: month prior to the underlying futures

CallsCall option buyer gets a long futures position

Call option seller gets a short futures position

Requires the opposite position in the same option. Same strike price, month, type and commodity

Options have zero time value after expiration

PutsBuying a put offsets an existing short put position

Selling a put offsets an existing long put position

Offset recovers both intrinsic and time value

Automatic exercise of options with intrinsic value on last trading day

Exercise recovers only intrinsic valueRemaining time value is lost

What Happens to Options


Premium Components

Premium

Time

Volatility

Interest Rates

Supply & Demand


Time Value Curve

24

• Time Value

Decreases at an increasing rate

Time value is zero at option expiration

Days to expiration

0

Time value

100

100

0


Non-Standard Options

Short Dated New Crop

WeekliesCalendar Spread Options (CSOs)

Inter-Commodity Spread Options

Corn

Soybeans

SRW Wheat

HRW Wheat

Soybean Meal

Soybean Oil

Corn

Soybeans

SRW Wheat

HRW Wheat

Soybean Meal

Soybean Oil

Corn

Soybeans

SRW Wheat

HRW Wheat

Live Cattle

Soybean-Corn Price Ratio

SRW Wheat- Corn

MGEX-KC Wheat

MGEX-SRW Wheat

KC-SRW Wheat

• SRW- Soft Red Winter (Chicago)• HRW- Hard Red Winter (KC)• MGEX- Hard Red Spring (Minneapolis)


•Definition:

- The Short-Dated Options on the deferred (new crop) months are early expiring options that reference the December Corn Contract, November Soybean Contract and July Wheat Contract

•Key Benefits:

- Cost-effective: lower premiums due to lesser time value- Facilitate hedging early in the planting and growing season- Manage risk during specific windows of the growing season at reduced

costs- Useful for trading around key USDA reports- Allow Greek sensitivity hedging- Can be used to hedge old/new crop positions- Arbitrage opportunities between outrights, CSOs and Short-Dated options

Short-dated New Crop Options


Short-Dated New Crop Option Listing Cycle


Weekly Options

• Same contract specs as standard and serial options, except for the listing cycle/expiration date.

• American exercise into the nearby futures contract.

• Expire every Friday that is not already a expiration date for standard or serial options.

• Four weekly options listed at any time. When one weekly option expires, a new weekly option will be listed on the following business day.

• Weekly options have a life span of about 28 days.


Side by Side Comparison - (Corn)

29

Product ExpirationDays Until

ExpiryUnderlying

* Approx Straddle

ATMVolatility

Weekly (Week 1)

7/3/2014 7September

Future 24 cents 36

Short-Dated New Crop

Option8/22/2014 53

December Future

40 cents 27

December(Standard Option)

11/22/2014 148December

Future57 cents 25


Calendar Spread Options – CSO’s

• A Calendar Spread Option is based on the difference between two unique futures contracts looking at the same underlying. For example, a July soybean contract vs. a November soybean contract.

• The spread is defined as the closest contract to maturity minus the deferred or farthest away contract:

Front Contract – Deferred Contract = Spread Price

• CSOs are sensitive only to the value and volatility of the spread itself, rather than the price of the underlying commodity.

Grain CSO’s

Corn

Wheat

Soybeans

Soybean Oil

Soybean Meal

Financial Integrity


CME Clearing:The Central Counterparty Clearing Model


Daily Settlement ProcessNo Debt System

CME Clearing

Losses collected Profits paid out


Types of Margin

Initial•Amount of money required per contract to initiate a futures position

•Required by both buyer and seller

•Different forms of capital accepted

Maintenance

•Minimum balance (equity) that must be maintained at all times

•If balance falls below maintenance level, you receive a margin call

Margin Calls must be made with cash

•Hedge initial margin is same as Spec Maintenance Margin

Benefits of CME Group Products


Disclaimer

36

Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade. All references to options refer to options on futures.

Swaps trading is not suitable for all investors, involves the risk of loss and should only be undertaken by investors who are ECPs within the meaning of section 1(a)12 of the Commodity Exchange Act. Swaps are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade.

Any research views expressed are those of the individual author and do not necessarily represent the views of the CME Group or its affiliates.

CME Group is a trademark of CME Group Inc. The Globe Logo, CME, Globex and Chicago Mercantile Exchange are trademarks of Chicago Mercantile Exchange Inc. CBOT and the Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago, Inc. NYMEX, New York Mercantile Exchange and ClearPort are registered trademarks of New York Mercantile Exchange, Inc. COMEX is a trademark of Commodity Exchange, Inc. KCBOT, KCBT and Kansas City Board of Trade are trademarks of The Board of Trade of Kansas City, Missouri, Inc. All other trademarks are the property of their respective owners.

The information within this presentation has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for any errors or omissions. Additionally, all examples in this presentation are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience.

All matters pertaining to rules and specifications herein are made subject to and are superseded by official Exchange rules. Current rules should be consulted in all cases concerning contract specifications.

Copyright © 2015 CME Group. All rights reserved.

risk management for agricultural markets steven stasys +1 [email protected]...

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