October 15, 2019
The storage hedge might be the dullest marketing strategy around. It may not be exciting, but it is effective. Let me explain.
We start with terminology. You might know the storage hedge as selling the carry or as a simple short hedge. The strategy is simple. It generally starts at harvest with grain placed in storage. It works best with a large carry in the market - deferred futures at a premium to nearby – a very common situation in corn, but currently available in soybeans and wheat.
The storage hedge occurs when you place grain in the bin and “sell the carry” by pricing grain for delivery later in the crop year.
Here is a simple formula to calculate the expected price from a storage hedge using futures:
____________________ + ___________ – ___ = ____________
futures price (when sold) + expected basis – fees = expected price
(Keep in mind that for most producers, basis is a negative number. Eighth grade algebra taught us that adding a negative number is like subtraction.)
The key is basis
The key here is basis, or the difference between your local cash price and the futures price. Basis has a strong tendency to narrow from harvest to the following spring/early summer. It is this strong tendency that makes the storage hedge a profitable opportunity.
The storage hedge can be achieved with a forward or HTA contract, but I prefer to do it with the sale of futures contracts. The key here is basis opportunity and flexibility - when and where to deliver grain and “unwind” my storage hedge.
Consider this scenario. It’s mid-March and a shuttle loading facility just bumped the corn basis 15 cents higher to fill a train. You don’t have to continue storing grain for another three months – you can make the sale and unwind the hedge (i.e., buy back futures).
Here’s another scenario. In late spring, your local elevator is bidding 15 cents under for corn, but you can get 2 cents under for corn delivered to the ethanol plant.
In each scenario, this flexibility creates a basis opportunity, and a chance for a better price.
What makes the storage hedge with futures so effective? Three reasons.
First, the storage hedge makes large carrying charges work to your advantage. If the carry from December to July corn futures is 30 cents per bushel, you get to put that carry in your pocket.
Second, once a sale of futures is made, you have a true hedge against any price erosion.
There is a common misconception, held by many producers, that futures prices tend to increase after harvest. For the record, July corn futures have traded higher from October 1 to May 1 in 20 of the last 40 years. In other words, there is a 50% chance that July futures will trade lower after harvest. Are you comfortable with those odds?
Finally, the storage hedge creates a basis opportunity, which narrows the focus of your attention. Are you waiting and hoping for higher prices after harvest. No! You hedged – sold futures – so higher or lower prices is not your primary concern. You are watching basis, seeking the ‘when and where’ to make final delivery of grain and unwind the hedge.
This is not a 50-50 proposition. Basis will narrow, and your job is to find the best basis for your grain in storage.
As a marketing strategy, the storage hedge is too dull for many producers. Dull, yes, but a very effective way to put the carry and basis gains in your pocket.
The storage hedge, using futures, in four steps
Place grain in storage
Price grain with the sale of deferred futures
Watch the basis narrow (boring – but look for opportunities!)
Unwind the hedge; i.e., sell grain and buy back futures
Edward Usset is a Grain Market Economist at the University of Minnesota, and author of the book “Grain Marketing is Simple (it’s just not easy).” You can reach him at [email protected].
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