July 20, 2017
The public looks at futures traders as the flash-and-dashers of the financial world. That’s certainly not the image most city folks have about agriculture.
But farmers spend a lot of time thinking about futures prices, even if only a third of them trade. Using futures, as well as options, in a marketing plan has some advantages. Chief among them is flexibility.
When a farmer sells cash grain, either from inventory or through a cash contract, that’s pretty much it. If yields come in short, or prices begin to rally, it’s possible to buy your way out of the contract. But those instances are the exception, not the rule.
With exchange-traded contracts, however, there’s always a way out. Those who sell futures can buy back the short position, though it could be at a loss. And those who want only short-term protection for periods of uncertainty can put it on and off as conditions dictate.
Of course, that’s the sales pitch. There may be good reasons for getting out of a hedge if crops begin baking in the field. Otherwise, this type of trading smacks of speculation, or at least trying to time the markets. Academic experts laugh at this effort, saying no one can really “beat” the market.
But what if they could?
We can’t offer definitive evidence that short-term trading is effective, documented by audits of actual trades and financial statements. But self-reporting from farmers responding to a recent Farm Futures survey suggests this type of “selective hedging” may work for some growers — if they follow some rules used by other traders.
We asked growers to grade their ability at taking short-term positions in futures or options. Those that gave themselves an “A” or a “B” were more likely to rank among the most profitable of the more than 1,200 farms we surveyed in March.
Then we asked growers if they used any of 15 methods for disciplining their sales. Those who used more than five of these were even more likely to be top earners.
Six of these tools appeared especially useful, showing a statistically significant correlation with high profitability:
Protecting futures positions with long options. This creates the “synthetic” equivalent of an option position, which can offer greater flexibility than just buying a put or a call by itself.
Selling covered options. With these positions, calls are sold against long futures, and puts are sold against short futures. The premiums earned by the short options offer some cushion against an adverse move on the futures side.
Rolling options to take profits. This involves selling a call option when it gains in value, then using some of the proceeds to buy another call with a higher strike price. Puts can also be rolled down, taking profits on the first and reinvesting some of them in a put further below the market.
Letting winners run. This adage means staying in a position as long as the trend is still in your favor, instead of taking small gains and getting out.
Using short-dated options. These relatively new products offer protection for shorter periods than traditional options, in exchange for lower premiums. They’re now offered on a weekly and monthly basis for old crop, with new crop puts and calls also available that expire months before their underlying futures contract.
Liquidating options before expiration. Another way to reduce the cost of puts and calls is to hold them for a limited time. Getting out of the positions before they expire is one way to salvage at least a little of their time value. It can add up over a period.
Growers who said they followed at least four of these ideas were over four times as likely to rank in the top 5% in profitability of the farms we surveyed. They also had more of their 2017 crops priced than the average producer surveyed.
Still, before hoping to become a gunslinger, remember the advice of one grower we surveyed who tried: “Lost money every time.”
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