Futures and Options
Agricultural Futures
Agricultural Options
Futures and options are financial instruments that allow you to protect yourself against fluctuating prices. Futures markets and options on futures contracts are a kind of price insurance, where you effectively pay extra (like an insurance premium) to reduce the risk of losing a lot.
The following gives a brief explanation of how they work. Contact your financial advisor or bank to see whether these are suitable for your financial strategy. For more information on futures and options go online and look at the Sydney Futures Exchange website (www.sfe.com.au) or the Australian Stock Exchange website (www.asx.com.au).
Agricultural futures are risk management tools used by agribusinesses to manage price swings within commodity markets so that they have more control over their bottom line.
If you're looking for a textbook definition, essentially agricultural futures are legally binding agreements, made through a futures exchange, to buy or sell something in the future. That "something" in context of the agricultural markets is usually a commodity such as corn, wheat, soybeans, oats, or any number of other commodities.
Futures markets bring together buyers and sellers who have opposing price risks. Sellers (i.e. farmers) are worried about commodity prices falling, while buyers (e.g. wool, cotton or wheat buyers) are worried about prices rising. Both parties have the opportunity of locking into a future price, by either buying or selling futures contracts.
Futures contracts are standardised according to the amount of commodity being bought or sold, the expected time and place of delivery, and the quality of the product. In fact, because futures contracts are standardised in every way except price, they can be useful if you want to plan ahead and protect yourself from dangerous price swings.
An agricultural option is a contract that conveys the right, but not the obligation, to buy or sell a futures contract at a certain price for a limited time period. The important words to remember from this definition are "...the right, but not the obligation..."
If you buy an option, you retain the right to "exercise"
or use the option if it works to your advantage, but you are not obligated to
do anything. An option seller, on the other hand, is obligated to buy or sell
the underlying contract, at a certain price, if the option is exercised by the
option buyer.
For this right the buyer of the option pays a premium to the seller of the option.
All terms of the option are standardised and established beforehand, except
for the premium. The premium can be seen as a price insurance premium.
Premiums are determined by market forces. Two types of premiums can be entered into. Put options give the buyer the right but not the obligation to sell the underlying futures contract. Farmers seeking to obtain price protection would use put options. Call options may also be purchased and these give the option buyer the right but not the obligation to buy the underlying futures contract.
Their advantages are:
As with any share-related speculation, there are also significant risks attached to futures and options:
