Hedging Crop Insurance with New Crop Weekly Options
New Crop Weekly options combine the low-cost premium of Weekly options with the targeted view of a new crop instrument, all based upon the most liquid and actively traded agricultural derivatives in the world. With New Crop Weekly options expiring on Fridays and settling to new crop Corn and Soybean futures, CME Group provides market participants with a flexible tool to fine-tune their cash market exposure or express a market view. New Crop Weekly options can serve as a low-cost tool to mitigate immediate-term risk associated with physical or financial positions.
Market-moving events such as USDA WASDE reports, changes in trade policy/geopolitics, and extreme weather can significantly impact volatility in agricultural markets. New Crop Weekly options give traders greater flexibility to manage volatility arising from these events, along with the added features of shorter expirations and lower premium.
Key features
- Expire Fridays from February to August, listed up to four weeks out
- Exercise into new crop futures contracts (December Corn and November Soybeans), offering the following benefits:
- Seasonal hedging to manage new crop month exposure
- Hedge “overlay” against long-term hedges or position in front of specific events
- Cost effective around early season WASDE reports
- Premium that historically costs less than front month-based Weekly options early in the calendar year
Case study: hedging corn revenue protection
Corn Revenue Protection (RP) is a crop insurance product issued by the USDA, and the parameters of which are set using commodity prices derived from CBOT Corn futures. Revenue Protection guarantees revenue based on the crop year’s projected and harvest prices, both of which are based upon December CBOT Corn futures settlement prices and vary by state (covering 31 states for Corn). In June 2022, the USDA released the Summary of Changes For The Commodity Exchange Price Provisions, which sets the schedule for determining the projected and harvest prices used in determining RP coverage for each state. More temperate states generally see earlier price discovery periods than do more northerly states to reflect the variation in growing season.
For Illinois, Indiana, Iowa, and Kansas, as well as most other Midwestern states, the projected price discovery period will span February 1-28, 2023. RP also takes volatility of the respective periods and instruments into account when determining coverage.
The following example explores the utility of New Crop Weekly options, in conjunction with Short-Dated New Crop (SDNC) options, throughout the month of February to hedge exposure to the Corn Revenue Protection projected price and premium, which are determined using average CBOT Corn futures daily settlement prices and volatility, respectively.
The strategy: risk reversal with New Crop Weekly and Short-Dated New Crop options
A corn producer (a “natural long”) seeks to hedge against downside price risk and lower projected prices per the 2023 Corn Revenue Protection program. New Crop Weekly options allow the producer to capture intra-month price movement and dynamically hedge during February while the RP-projected price is being calculated from an average on the new crop future.
On February 1, 2023, December 2023 Corn futures are at 600 cents per bushel. Our producer buys one at-the-money (ATM) Week 2 New Crop put option for approximately 7 cents and sells one SDNC option call at a 620-strike price for 2.5 cents. The two option contracts have different expiration dates with the Week 2 option expiring on February 10, 2023, vs. the March SDNC on Feb 24, 2023. The fact that the Week 2 option has fewer days until expiration leads to more sensitivity in price early in the month. This allows a participant to better capture any downward movement in the first eight averaging days. The period of February 1-9 comprises 40% of the 20-day averaging period in the calculation of the RP-projected price.
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1 Buy one ATM (600) Week 2 NC put for 7c |
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9 Roll the New Crop put into a SDNC put |
10 New Crop Week 2 options expire |
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20 President’s Day
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24 Short-Dated New Crop March options expire
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As Feb 10, 2023 approaches, the hedger can dynamically roll the Week 2 New Crop put into a March 2023 SDNC ATM put the day before the Week 2 New Crop option expiration to catch the second half of the averaging period. The producer sells the Week 2 New Crop put option before expiration to avoid the option’s most aggressive theta decay and thus reduce the net premium of the strategy. The hedger has optionality at this point in the month on how to treat the remaining averaging period.
By buying a New Crop Week 2 put and rolling it into a March SDNC put, a hedger has coverage for 18 of the 20 days of the averaging period. This strategy breaks up the month of February 2023 into two halves, separating the different risks incurred by buyers of RP late and early within the month. The New Crop Week 2 put, bought on February 1, 2023, carries a bearish view on early month price movement. The Short Dated New Crop March ATM call, sold on February 1, 2023, offsets some of the premium incurred by the New Crop Week 2 put while capping upside movement.
The combination of one long put and one short call creates a “collar.” The collar structure allows the participant to fully hedge downside exposure against a strong move at multiple points within the month, but limits upside potential from a higher revenue protection price and exposures short-term losses if prices rally.
Another angle: horizontal put spread
Selling a call, however, can lead to a mismatch of cash flows with a loss incurred in late February with the benefit of a higher RP price not possibly seen until later in the year. If a participant is bullish and does not want to have upside exposure by selling a call, another strategy would be to sell a March SDNC 580 put at the beginning of the month in place of the 620 call. This would create a horizontal put spread, giving some downside protection and not capping the upside. The further out-of-the-money put sale helps lower overall premium costs for the ATM New Crop Week 2 put. The same dynamic roll is applicable between the New Crop Week 2 put and the ATM SDNC put approaching the Feb 10, 2023 expiration.
Covering your bases
The payoff to the producer is dependent on the size of his yield, his input costs, the level of USDA Revenue Protection he will use, and at what price he will be able to sell his corn at harvest time. A higher RP-projected price will result in higher revenue guarantees, though in recent years rising input costs have functionally resulted in a lower overall degree of coverage. The discussed strategies aim to protect the participant against a lower RP price while minimizing premium costs and capture a monthly average price. New Crop Weekly options grant a unique combination of intra-month exposure in combination with the March Short-Dated New Crop options, allowing for dynamic hedging during the February averaging period. With the addition of New Crop Weekly options, CME Group offers participants more ways to hedge risk. Learn more at cmegroup.com/shortdatedoptions and reach out to your broker for more detail.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
