Could heavy rains nurture grain options in the UK?

Could wet weather nurture grain options in the UK?

While growers in the European Union's third-ranked wheat producer have become increasingly aware of futures as a way of guaranteeing prices by selling ahead, options have yet to catch on in a big way.

"Very few farmers use them," Jack Watts at the UK's HGCA crop bureau said.

"They are largely put off by the complications involved in them," especially in the UK's tight financial services regime.

"The uptake has been relatively minimal among farmers," proving more common among larger enterprises such as mills and feed groups further alone the value chain.

Tempting prices

However, the dismal weather taxing UK farmers certainly makes a case for using options, which allow farmers to sell crop in advance but, unlike futures, do not oblige a sale.

London futures are offering farmers, at £187.50 a tonne for the November 2013 contract, tempting prices for their next wheat crop. The price compares to figures below £145 a tonne for the November 2012 contract a year ago.

But growers have been reluctant to lock-in such high values because of the slow progress on sowings, which are running well behind the normal pace, as reported last week, leaving many to worry that they may have very little crop to sell next year.

Cumulative trading volumes for the November 2013 contract, from all sources, are running some 40% behind those a year ago, with a grain trader telling Agrimoney that sales from producers have slowed "to a trickle".

In theory, options allow farmers a way of locking in high values with lumbering themselves with the responsibility to deliver.

Popular in the US

Certainly, options are popular with US growers.

"Over the last 15 years, producers have become much more astute in their marketing strategies, including options," Jason Roose at broker US Commodities said, estimating that 50-60% employ some form of hedging.

"And more use options than futures," given their flexibility.

Indeed, at Linn Group, Roy Huckabay, a principle at the Chicago-based company, flagged strategies including both put options, which protect against price falls, and call options, which allow growers to benefit more from price gains.

Nor was the US crop insurance programme a substitute, with "very few people" taking this protection neat rather than enhancing its flexibility through an options strategy.

'Liquidity is very thin'

However, there are fair reasons why UK growers are more sceptical not least because the London options market is far less liquid than its Chicago counterpart, besides a reluctance to pay the upfront charge.

For UK feed wheat, at-the-money options with a strike price at the current futures prices for November 2013 can in theory be bought for £20 a tonne, locking in next year's high price.

"But they may be difficult to as liquidity in the market is very thin", Mr Watts said, suggesting buying better-traded options against Paris-traded milling wheat as a proxy.

"To reduce the cost, an out-of-the-money option can be used," with a saving of some £8 a tonne gained for an option E10 a tonne away from the current price.

'Cultural thing'

A UK grain trader said: "It's an interesting idea. But it introduces currency risk into the mix as well as the different dynamics of the feed and milling wheat markets."

Not that options were a no hoper in the UK.

"It is to some extent a cultural thing. Farmers used to be reluctant to take out protection for sterling against the euro," the currency to which European subsidy payouts are pegged, "which went on to become popular."

'Most options expire worthless'

Still, it is not all upside for options, as Jerry Gidel at US broker Rice Dairy said.

"There is the cost involved," in terms of the cost of the position and the margin on maintaining it.

"And they do say that most options expire worthless, and that the people who make money from options are the people who sell them, not buy them."

In the UK, many growers opt for minimum price contracts with merchants, which in essence see the merchant sell a futures contract and repackage it to the producer.

"That is a simple way for farmers to deal with what can be a sophisticated concept," Mr Watts said.

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