Commodity Terminology: Understanding Hedging, Puts and Calls September 28, 2011 Travis Carter

1. Commodity Terminology: Understanding Hedging, Puts and Calls September 28, 2011 Travis Carter

2. Cash Market • Futures • Buy, Sell • Options • Puts, Calls??? • What are they and how do I use them??

3. Cash Market vs Futures Market • Cash Market • a market which focuses on the buying and selling of the physical commodity for immediate or delayed delivery • Futures Market • buying or selling of exchange traded futures contracts • a transferable agreement to make or take delivery of a standardized amount and quality of a specified commodity at a specified point in time and location • think of it as a market offering a temporary sale or purchase of your commodity • can resolve agreements with money rather than delivery

4. Cash Sale • Execution: • Deliver grain to Elevator • Sell grain at the current bid • Receive payment • Strategy:Use this tool when the cash price has met your objective. The futures and the basis levels may both be at favorable levels or one may be significantly stronger than normal to compensate for the weaker factor.

5. Cash Sale • Advantages: •        Easy to execute •        Receive payment immediately •        Eliminates all risk of price decrease •        No storage costs or risk • Disadvantages: •        Futures and basis are both locked in •        Inability to participate in a market rally •        Delivery is required

6. Forward Cash Contract • Execution: • Contact Elevator to lock in cash price for some time frame in the future • Deliver grain as agreed • Receive payment • Strategy:This contract can be used for two different marketing strategies: • Use the forward contract to lock in a favorable new crop price before your crop is planted or harvested. • The forward contract can also be used to "lock in a carry." The market may pay more for grain delivered at a later date. If the forward price is greater than the current price plus your storage and interest costs, it would be beneficial to lock in the higher price.

7. Forward Cash Contract • Advantages: •        Easy to execute •        Eliminates all risk of price decrease •        Ability to lock in the carry • Disadvantages: •        Payment is not received until delivery •        Futures and basis are both locked in •        Inability to participate in a market rally •        Delivery is required •        Potential penalty for cancellation

8. Hedge: Hedging is defined as offsetting the risk of an adverse change in the cash market by entering an appropriate futures market position simultaneously. As long as the cash price and futures price move at the same rate, any loss in one market will be offset by a gain in the other.

9. Hedging • Hedging • based on idea that cash and futures markets are related and move up and down together • relationship between cash and futures is measured by basis • Basis • cash price minus the futures price • basis is not a constant; can get weaker (smaller value) or stronger (larger value) Remember, the futures market is used only for a temporary sale of your commodity

10. Basis Seasonality

11. +65 k -36 k -15 K +35 K

12. Basis Impacts?

13. Hedging • Corn producer example • Bob’s corn crop is planted and growing, corn available for sale after harvest • What is the risk of a price change? • Price may decrease! • What futures position will offset the loss from a price decrease? • sell futures (short the corn market) • Net result if cash price changes: • loss on the cash market is offset by a gain on the futures position • loss on the futures market is offset by a gain on the cash position

14. FUTURES CONTRACT SPECIFICATIONS • Standardized Amount • Contract Quantity = 5,000 bu. • Specified Time • Contract months for Corn • Dec, Mar, May, July, Sep • Standardized Quality • Deliverable grades vary by contract examples: • 1) CBT Corn • USDA #2 yellow corn

15. Grain MarketsFutures Understanding their use: • Though futures contracts are firm commitments to buy or sell grain, they do not necessarily require the actual delivery of grain. • As long as an offsetting position is taken prior to the delivery date no delivery takes place • Only a very small percent of futures contracts are actually delivered – in the case of the elevator it would almost never happen • A futures position can be initiated, or “opened”, be either buying or selling a futures contract – no existing futures position is necessary • Long futures position – Bought futures contract to take delivery • Short futures position – Sold futures contract to make delivery • Again, as long as the position is offset prior to the delivery date, the obligation to make or take delivery is removed.

16. FND and LTD Delivery Process – What is it? How does it work? • If you are long futures, hedges need to be lifted or rolled prior to First Notice Day or else you will have to pick up the physical commodity at a specified delivery location. • If you are short futures, hedges need to be lifted or rolled prior to Last Trading Day or else you will have to deliver the physical commodity to a specified delivery location.

17. First Notice and Last Trading Dates Corn ( C ) Soybeans ( S ) • July (CN) • FND = 6/29 • LTD = 7/13 • September (CU) • FND = 8/31 • LTD = 9/1 • December (CZ) • FND = 11/30 • LTD = 12/14 • January (SF) • FND =12/29 • LTD = 1/12 • March (SH) • FND = 2/28 • LTD = 3/14 • May (SK) • FND = 4/30 • LTD = 5/14 • July (SN) • FND = 6/29 • LTD = 7/13 • September(SU) • FND = 8/31 • LTD = 9/14 • November (SX) • FND = 10/31 • LTD = 11/14 • March (CH) • FND = 2/28 • LTD = 3/14 • May (CK) • FND = 4/30 • LTD = 5/14

18. MARGIN CALLS • Margin • money deposited by all traders when entering the futures market to assure performance for all participants • usually a small portion of the total contract value • Will ReceiveMargin Calls if market moves against your position • Commission • fee paid to broker for executing a trade in the futures market • based on “round-turn” or entry and exit of a contract

19. Recap • Futures • Temporary purchase or sale of commodity • Buy futures allows you to profit if market goes up • Selling futures will protect you from falling prices • FND and LTD • Remember what you have for positions around these dates • Also any orders that you have place with your broker • ie. Open Orders

20. UNDERSTANDING OPTIONS • Options on Futures • represent the RIGHT, (but not the obligation) to enter a designated contract at a specific price • the owner of an option is not required to enter a futures position • Types of Options • “Call" option • “Put" option

21. Options • Call • Gives the option buyer the right to buy (go long) a particular futures contract. • Put • It gives the option buyer the right to sell (go short) a particular futures contract.

22. UNDERSTANDING OPTIONSON FUTURES CONTRACTS • Strike price • price at which the option buyer has the right to sell (for a put) or buy (for a call) the underlying contract • Option premium • the market value of the right; quoted in cents per bushel for grain (times 5,000 bu.) • Option expiration • options expire around the 25th day of the month before the underlying futures contract month

23. “Real Life” Similarities THE ‘LAND EXAMPLE’ • Abe has 80 acres he’d like to sell at $3,000/acre. Bob has 80 acres adjacent to Abe’s and would like to buy them, however, he needs a month to get financing established.

24. “Real Life” Similarities Bob offers Abe $200 an acre to buy the 80 acres for $3,000 within the next 30 days – Abe accepts the offer. • What kind of option is this? • Call Option • What does the $3,000/acre represent? • Strike Price • What does the $200/acre represent? • Option Premium • What would be ‘worth’ more: a 30 day option or a 60 day option? • 60 Day Option

25. “Real Life” Similarities What if Abe was approached by Bob and Cliff, each needing one month to meet with their banker, and they went back-and-forth bidding the price of the option up from $200/acre to $500/acre? • This is the “price discovery” method used to find the value of the option, similar to how futures prices are determined – an auction.

26. “Real Life” Similarities PUTS: SIMILARITIES TO INSURANCE Car Insurance Buyers: • Pay a premium up front • In exchange, you receive a certain amount of protection should the value of your auto drop due to a wreck.

27. “Real Life” Similarities PUTS: SIMILARITIES TO INSURANCE Put Option Buyers: • Pay a premium up front • In exchange, you receive a certain amount of price protection should the futures market encounter a “wreck”. • Puts give the buyer downside protection

28. Options

29. Option Strike Prices • At the money (ATM) • option strike price that is equal or very close to the current market price of the underlying futures contract • In the money (ITM) – option strike price that currently has intrinsic value • Out of the money (OTM) • option strike price that has no intrinsic value

30. Puts Calls

31. Options Premiums • INTRINSIC VALUE = The difference between the strike price of the option and the price of the underlying commodity futures contract. If the strike price for a put option is lower than the price of the underlying futures contract, the intrinsic value is zero • TIME VALUE = Any value that is not calculated as intrinsic value falls into the time value category • INTRINSIC VALUE + TIME VALUE = PREMIUM

32. Options Pricing – Time Decay

33. Options Pricing • December corn futures are $6.00. A December’12 corn $6.20 put has a premium of $0.58 • What is this option’s intrinsic value (if any)? • What is this option’s time value? • Put intrinsic value = strike price - futures price • Time value = option premium - intrinsic value $6.20 - $6.00 = $0.20 $0.38 - = $0.58 $0.20

34. Options Pricing • November soybean futures are $13.20. A November $13.50 call costs $0.20 • What is the intrinsic value (if any)? • What is the time value? • Call intrinsic value = futures price - strike price • Time value = option premium - intrinsic value = $13.20 - $0.00 $13.50 $0.00 $0.20 = $0.20 -

35. Option Recap • What do you want to protect? • Upside (buy calls) • Downside (buy puts) • How much premium are you willing to spend on that protection? • Know when option expiration is if you have an option on a futures contract

36. Contact Information Travis Carter Office: 800.854.6490 Travis.Carter@FCStone.com This data and these comments are provided for information purposes only and are not intended to be used for specific trading strategies. Commodity trading is risky and FCStone Group, Inc., International Assets Holding Corporation, and their affiliates assume no liability for the use of any information contained herein. Although all information is believed to be reliable, we cannot guarantee its accuracy and completeness. Past financial results are not necessarily indicative of future performance. Any examples given are strictly hypothetical and no representation is being made that any person will or is likely to achieve profits or losses similar to those examples. References to and discussions of exchange traded products are made solely on behalf of FCStone, LLC. References to and discussions of OTC products are made solely on behalf of INTL Hanley, LLC, and OTC products are only available to eligible counterparties.

37. Marketing Grain with MPCI September 28, 2011 Travis Carter

38. Marketing Grain • Why do the markets do what they do??? • Marketing grain using cash and futures markets • Using options to market grain • Keeping track of grain marketing opportunities • Maximizing your MPCI with marketing tools

39. Weather! • Drought • Flood

41. Seasonal Corn Chart

42. Technical Analysis

43. Hedge To Arrive Contract HEDGE TO ARRIVE (FUTURES ONLY) CONTRACT PRODUCER INFORMATION • Hedge to arrive contracts establish a futures price component w/ basis to be determined at a later date. Use this contract when futures are high and basis is historically or seasonally wide. PROCEDURE • Negotiate a delivery date, quantity, and futures position as in the contract through your local elevator. 2. Establish futures price before or on first delivery date. 3. Deliver grain as stated in contract. 4. Receive cash payment upon delivery. 5. Service charges likely apply.

44. Hedge To Arrive Contract POSITIVES • Lock in Futures market price with opportunity for basis gains. • Take advantage of carry in the market and allow your grain storage to add value just like a grain elevator. NEGATIVES • Potential basis losses if basis widens prior to delivery. • Will be a contract with a particular entity to deliver grain.

45. Price Later Contract PRICE LATER CONTRACT (or NPE,DP) PRODUCER INFORMATION • Price later contracts allow producers a high degree of price flexibility for an extended time period. A service charge may or may not be used by your local elevator during the marketing year. If service charge is being used, a price increase must be expected to offset this expense. PROCEDURE 1. Negotiate service charges, if any, and pricing time period through your local elevator. 2. Deliver your grain to the elevator as stated in contract. 3. Price the grain sometime during the pricing time slot. 4. Receive cash payment once priced.

46. Price Later Contract POSITIVES • Pricing flexibility is all aspects, futures and basis. • Delivery and pricing date are not associated. • Storage risk and costs are transferred. • Frees up farm storage for new crop. NEGATIVES • Involves the transfer of grain title. • Required to deliver grain as stated in contract. • Payment is not received until the price is fixed. • Service charges (These are not storage charges) vary depending on the time of the crop year. • Open to price risks.

47. Minimum Price Contract MINIMUM PRICE CONTRACT PRODUCER INFORMATION • The minimum price contract is a very safe opportunity for the producer to participate in market movement for further profit. The producer should use when he anticipates a favorable market move that will enhance his base price but wants to market and lock in minimum price. PROCEDURE • Contact your local elevator for a variety of option strike levels and corresponding futures months. • Select a futures month, strike level, and premium level of a CALL option that will be used to reference this cash contract. • Option premium plus service charge will be subtracted from cash grain price to establish floor or base price. 4. Receive a cash payment equal to the established base price. • Final pricing is established by referencing the difference between current futures and the strike price.

48. Minimum Price Contract POSITIVES • Very safe—all costs defined. • Receive base or floor price up front. • Can participate in market rally with defined risk (premium). • Premium may be cheap compared to interest, storage, drying, shrink, and handling costs. • Flexible—can be used with a variety of contract strategies. NEGATIVES • Lose basis opportunity at harvest time. • Premium and service charges may be costly. • Must market option to add value. • Lose time value if producer waits until contract expiration is near to market option. • If market has no movement, premium is wasted.

49. Hedging with Puts • Hedge • You bought a March corn $6.70 put for $0.13 • Local basis is -$0.40 the March • What is your minimum cash price? • Cash price = futures price + basis - option premium $6.17 = $6.70 + -$0.40 - $0.13

50. Hedging with Puts • Soybeans • You bought a July soybean $14.40 put for $0.85 • Local basis is -$0.50 the July • What is your minimum cash price? • Cash price = futures price + basis - option premium $13.05 = $14.40 + -$0.50 - $0.85