Hey All, I have a friend who owns a deli. She's recently been hurt by the volatility of flour in the market, specifically by a nasty spike in the price of flour a couple months ago: https://www.bloomberg.com/quote/W 1:COM What's a reasonable hedge for her? Buy a call or sell a put against the wheat index? Maybe some type of iron pelican or something? What can she do to protect herself against the volatility of flour? Perhaps this is more of a derivatives question, but since it's a commodity, I figured I'd start here. Thanks for your help.
I believe you are referring to an iron condor, or perhaps an iron butterfly. Either one is good for decorating a bakery. For an extra effect, put the "We are short Vega!" slogan on the front door.
Well, yes, wheat futures is a derivative. A derivative of the underlying commodity. Wheat. Different kinds of wheat out there. But I would figure that the benefit of hedging wheat futures would be for huge manufacturers of wheat-based products, that need tons of wheat per week, rather than a deli owner who sells bread/crackers/cakes, and perhaps makes their own bread with the flour. But those futures are for thousands of bushels. Does a deli owner need to hedge against their retail cost? Geez, how much bread is the deli owner making? It seem that a better hedge for a deli owner would be to either make the sandwiches a bit more tasty, or to slightly raise the price of wheat-based products that they sell.
You need to figure out the quantity, as @Overnight stated, it makes no sense to hedge for less than 5000 bushels. Usually you will go short or long the future (or some kind of structured product offered by a bank or otc option provider) and get a credit line to cover the p&l before settlement.
I guess you are talking about 26 Jun 17 where price went up significantly. It peaked at 574. You could have bought Wheat futures, buy call (or sell put) option hedge with vertical spread. I see that wheat futures has sinced dropped significantly to 416 level, ie 27% drop from peak over a period of just 2 months. other soft commodities (eg soyabean) also exhibited similar pattern.
I have seen too many small companies try this in past 35 years and only to lose even more. They are far from experts of future prices and doing options or different plays in options can make it much worse. How about a co-op with another firm for each to buy half truckload of flour and store it in rental storage? To me this make more sense than going into area they have no experience in. Flour is off the highs by over a buck in December contract and headed lower, how much? Anyone's guess. And if you can't talk them out of hedging, contact Bone on spreading be more sense to me then laying out for decaying options.
This is going to end up in disaster.... How big is the deli business? Shouldn't she just raise prices slightly to cover the increase in base materials costs? Also... how much is the cost of 'flour' compared to the rest of her business? Those are the questions she should ask... not how to hedge through derivatives... Somehow, I doubt that flour is that big of a cost in her production... so the effect of a 20% increase in one part of base materials shouldn't really be that big of an impact in bottom line...
http://www.cockeyed.com/inside/sandwich/calcutron.php So, how much does the flour/bread part in a sandwich cost as part of costprice... About 10% ... of materials... so add wages and rent etc... and you're looking at what... 3-5%? Of costs? Less?? So I'll argue that it's not the price of flour hurting her business, but likely something else... because a 1% increase in costs shouldn't hurt business... This isn't a question for trading... but for business structuring... To hedge something like this, is like putting on a hedge by long CL to cover my expenses in chain lubrication for my ride to work bicycle....