This spring Matt Swanson had more on his mind than just dodging weather to get crops in the ground. With a bull market raging Swanson, like countless other grain farmers, has high hopes for lucrative sales that could replenish bank accounts for years to come.
“The way the supply situation is now, I expect the market to get spicy,” says Swanson, who farms in Illinois and Arkansas. “The market could go up; it could go down. We set price targets and as they get hit, we make sales. Once we feel a lot of the risks are in the market we’ll try to capitalize, whether that’s buying puts, selling calls, or a combination of both.”
Grain farmers are looking at a host of ways to exploit a jumpy market. The number of acres planted this spring, along with any weather hiccup, could send shockwaves through the market long before one bushel gets harvested. This spring saw an acute battle for acres as the soybean balance sheet is the tightest ever heading into new crop. And corn? If China keeps snapping up bushels anything short of trend yields will very likely cause prices to blow up.
“We all know there’s a weather market coming,” says Orrin Strand, who grows corn and soybeans near Albion, NE. He’s scouring reports on weather patterns and trying to gauge what happens when the Pacific cools and La Niña transitions to neutral. He’s using Cargill’s Focal Point program to scale up sales if prices strengthen.
“We’ll be interested in how this summer unfolds, especially with drought in the western corn belt,” says Strand, who still had 25% of his 2020 corn crop unpriced as of April.
Worth waiting for
After years of modest profits 2021 is the growing season grain farmers had been waiting for — if all goes right. But that’s a big “if,” for a host of reasons. Hot markets don’t mean a lot if you don’t have much to sell, although crop insurance should mitigate revenue risk. And even though highs in new crop corn and soybeans come more often during this season than any other, success isn’t guaranteed. Pulling the trigger on sales isn’t easy; some years rallies are fleeting if they come at all.
Still, tight old crop stock numbers don’t lie, and farmers hope to strike while the iron is hot. Strong demand and fears U.S. farmers won’t plant needed acreage should make traders sensitive to any threat that heat, or drought, could damage crops.
This year there was extra incentive for farmers to keep planters running: Spring futures prices offered a carrot of triple digit profits for both crops. Adding safety net programs like Agriculture Risk Coverage and Revenue Protection crop insurance pretty much assured a profit for the average grower regardless of what happened to final prices and yields.
But then, no one wants to be average. And if you sold 2020 crop ahead of the big price surge last winter, you’re feeling a bit stung by this market. So maybe you’re feeling an extra incentive to put 2020 behind you and cash in with profitable new crop sales.
But, therein lies the dilemma for many growers: what If I pull the trigger too early? What if I wait too long and miss out?
Doing nothing has its own risk. Trying to pick the top of the market could mean waiting too long, then becoming that deer frozen in the headlights if prices crash into harvest. Losses are possible on both corn and soybeans if prices and yields fall enough.
Fortunately, farmers have myriad tools and strategies for managing that risk. But there’s no one-size-fits-all marketing plan. If there’s one thing we’ve learned over the years it’s that each farmer’s marketing plans are as different as night and day. Consider these choices:
Just sell it. The easiest way to sell your crop is just that: Make straight sales with cash or futures contracts. Pricing 80% of the crop and relying on RP and ARC for a safety net makes it hard to come up with a combination of yields and prices that are unprofitable.
Second chance. Of course, in a big year the goal is not just to avoid losses, but to make money. Call options are the most straight-forward way of covering risk from rising prices after a sale is made. Calls increase in value if futures rise enough, and these proceeds can be added to the selling price.
Put it together. The short futures (or cash), long call position is known as a synthetic put because it mimics results from buying a put. This type of option covers some of the downside risk, while leaving room for appreciation if prices rise enough. Using the long call alternative allows more flexibility: the option can be purchased before or after the sale.
The options trap. The drawback to buying options is their cost, which is inflated by high futures and volatility. If futures are flat, most or all of the premium can be lost. The options would hold on to a little of that value at harvest, but time value decay could still eat into their value. And revenues would still be higher than ARC or RP triggers.
One potential solution would be to roll puts into a short futures (cash) position or liquidate call options once the crop is made in August or early September. That could recover more of the initial premium paid up front for the option but provide less protection against market surprises.
The write way. Another alternative is to sell other options to lower the cost of the contracts purchased. An out-of-the-money call can be sold to finance a put option purchase, for example, a strategy known as a collar. Cutting the net cost of the price protection comes with caveat: The short calls incur margin exposure unless done through hybrid cash contracts. And if futures rise enough the short call’s strike price becomes the maximum selling price, less net options premiums.
Know “Greek.” When trading options it’s important to consider delta. An at-the-money option generally has a delta around 0.5. That is, it will capture around 50% of the move in the underlying futures contract initially. Combining a short call with a long put increases the delta, making the position perform more like an outright futures sale.
Delta can also lower protection from options spreads. Buying an at-the-money call and selling an out-of-the-money option against this lowers the net delta of this “bull call” spread. The position loses less in premiums if futures don’t rally, but also gains less if there is a big move. Out-of-the-money puts can be sold to finance a put with a higher strike price, but downside protection will be capped too. Futures sales can also be “covered” by selling an out-of-the-money put. This adds premium value but caps downside protection from the futures sale.
There are many ways of adjusting the cost and resulting delta of an options trade. Just remember that the delta of a short futures position is −1, then combine this with the net delta of the options position.
Buying bargains. Another way to lower the options premium is to buy cheaper, out-of-the-money puts or calls. These provide less protection due to their lower deltas but may be enough to guarantee a decent profit. Using short-dated new crop options lowers cost but provides protection for less time, risking expirations that occur before harvest.
Larry Johnson, who farms 5,900 acres with three sons near Carlyle, Ill. has capacity to store 400,000 bu. corn and 150,000 bu. soybeans, but he still needs to find a home for some of the farm’s expected production with normal yields.
“We mainly use harvest and grain bins for marketing strategies,” says Johnson, who has multiple outlets for corn and farms in eight counties.
Johnson got his inputs purchased early when they were cheaper than today, so his breakeven price gives him some flexibility. “I can make money at $4-per-bushel corn with normal yields, so you need to take a little advantage of that,” he says.
Johnson watches carryover numbers and stocks-to-usage as a way to anticipate price moves. “In the past, 10% of usage is going to result in over $5 corn; when you see 15% usage, corn prices can drop as low as $3.80, based on the past five years,” he says. “Those correlations are pretty accurate.”
Bill Furlong, who grows corn and soybeans in east central Iowa, has no on-farm storage and usually presells 80% of the expected crop. “That didn’t work well in 2020 but it has worked well four of the last five years,” he says. “The last 20% I usually take market price at harvest. “After I delivered grain the corn market went up $2,” he notes. “That wasn’t so smart. If I had used options and/or futures I would have gained back part of that, so that’s what I’m planning to do this year.”
By April this spring Furlong had presold 40% of corn and soybeans for fall cash delivery, with sales ranging from $3.80 to $4.60 corn. “I’m using options to protect half of the 60% I have not sold,” he explains. “I have no expectations for what will happen with this market. Futures is high stakes gambling and some people are good at it, but not many.”
Furlong’s bank expects loans repaid by Jan. 20 instead of carrying a note in to the next year. “That has always forced me to be a marketer,” he adds. “It’s worked for me.”
Matt Swanson also sold 2020 crop before the big rally began, but still made money with sales at $4 and $4.30, based on break evens – something he carefully monitors as the growing season unfolds.
“It would be nice to have those bushels back, but at the end of the day they were profitable sales and we made them for a reason,” he says. “A lot of guys don’t have a good enough handle on what their costs are, but I don’t like guessing. You can’t go broke making money and when you’re a young guy you have to make sales when they are profitable, and we haven’t had a chance to do a lot of that the last few years.”
Swanson started selling ‘21 corn in July of 2019 when it hit $4 per bu. He markets in a two-year window, “which usually allows us to average out good sales,” he says. “We’re looking at some 2022 sales, but I’d like to see where the next 8 to 10 weeks go before we make decisions.
“Let’s face it, we’re not going to go broke at $4.25,” he says. “And at some point supply is going to catch up with us. Brazil is too good at what they do, and we’re too good at what we do.”
And, if this market does get spicy, as Swanson suspects it will, this summer may be the best chance in a long time to put your business on the fast track to prosperity.
Three things to track the next two months
- Crop conditions reports – learn how crops are developing outside your region https://usda.library.cornell.edu/concern/publications/8336h188j
- U.S. drought monitor – pretty self-explanatory - https://droughtmonitor.unl.edu/
- Short-term weather forecasts from NOAA - https://origin.wpc.ncep.noaa.gov/basicwx/basicwx_ndfd.php