Paul Georgy is president of Allendale, Inc., a global agricultural advisory and research firm. He also represents the introducing broker community on the board of directors of National Futures Association. He also serves as a member of the NFA Executive Committee. Georgy is a former president of the National Introducing Brokers Association and is a member of its Honors Circle. He spoke with JLN Options editor Sarah Rudolph about how the use of options on agricultural commodities has been changing and evolving.
Q: How are commercial users using options now?
A: They use options in combination with the futures markets to control risk. We work mostly with retail accounts at Allendale, who are using options to try to eliminate margin risk. We see traders using the options in a shorter duration, as protection for a two- or three- week time period, for example through a USDA report or weather forecast over a long weekend.
Q: What types of retail traders have accounts with you?
A: We have livestock and grain producers who use options in order to sell or price their grain instead of using futures. This is a way to market their production instead of selling cash at the grain elevator. They’ll use an options strategy to protect the downside or the upside, whichever necessary. For example, a user of grain who needs to buy grain for feed in his poultry operation might use a call spread, or a grain producer might buy puts to protect production costs.
Q: Has your business changed greatly since you started out as a cattle manager?
A: Yes, it has changed considerably in recent years. We’ve been in the business nearly 30 years. It used to be that people would buy a call or a put and hold it for the duration of the option, and they wondered why they lost money. Traders now realize options are a tool and sometimes they must change their tools during the marketing process. You can’t just forget about your options position; you have to manage it and be able to get out of it. We’re seeing a lot more focus today on getting best price for your production by using more complex strategies.
Q: Why is that?
A: Risk and margin money is a big thing. The public doesn’t like meeting unlimited margin calls for their hedges. We try to help them manage that margin money need by using options, and still allow them to be protected in the market. For example, if a customer needs to protect against a downside in corn, they might sell the futures, or sell cash at an elevator, and then buy a call or call spread to benefit if the market goes higher. That also reduces the margin requirement on the futures position.
Q: How has the rise in hedge funds and funds of funds affected the agricultural markets? Has it made them more volatile or more directional (trending)?
A: I think the funds and money managers have had a positive impact on the markets. They create more volume and liquidity. Their involvement also has a tendency to make the market more directional than in the past. This gives producers a lot of opportunities they didn’t have before. It used to be that a hedger or marketer of grain was always fighting the trend because he knew he had only a limited time to sell. When the market would go up, his job was to sell the grain, and he had to pick a price and sell it. Today he can pick a price, sell his grain, and use options to benefit if the market goes higher. That allows him to be less exact than he had to be in the past, and gives him more alternatives when using options than in the past.
Q: Are more institutional players using Ag options now – hedge funds, CTAs, banks, etc?
A: I think the volume is coming from all sectors of commercial users. They all use options for managing their risk, and they use more complex options strategies than a retail user is comfortable with. They use options analysis programs to protect their purchases or sales. We see that in the CFTC reports when you look at futures only compared to total futures. When factoring in options it changes their net positions.
Q: Have the Dodd-Frank regulations affected trading in the Ag options?
A: They haven’t yet, but that is certainly a concern. It may have an impact down the road, especially since the regulatory organizations are still writing the rules.
Q: What else has changed in the industry in recent years?
A: I think the big change in the futures industry is the number of contracts and the greater number of opportunities. You have the ability to think out of the box and create different strategies today. When I started in the ‘80s we only had a few things we could do for hedging which was transfer risk by using futures alone. Now, with the expansion of the money flow into the futures industry, and with options, it creates a lot of opportunities.
Q: What are the biggest issues or questions that come up at your educational seminars?
A: One of the biggest questions in our industry is how to use options and control margin risk and margin calls. That is the number one thing on retail users’ minds. We try to help the user of these options, whether a producer or speculator, to understand the many strategies that can be used — straddles and strangles, call and put spreads, etc. We start out by teaching basic options strategies and work into more elaborate strategies.
When I started, there was less volatility in the markets. Corn would have a price move of 75 cents to a dollar in one year. Now we have a price range of $1.75 in seven days. This volatility creates the margin requirement risk and a concern for producers. We help them use these vehicles to price their grain and livestock in order to withstand this volatility and price risk.