February 19, 2021
Each month in Wallaces Farmer magazine, the Timely Tips panel answers questions sent by readers. Members of the Timely Tips panel are Alejandro Plastina and Wendong Zhang, Extension economists, Iowa State University; Leslie Miller, Marion County Savings Bank, Knoxville; and Rob Stout, Master Farmer, Washington, Iowa.
In years past, I’ve missed opportunities to sell new-crop corn during a spring rally in December futures prices. How can I use crop insurance to lock in a profit on the futures market? What level of coverage should I opt for?
Stout: There are too many variables for me to recommend one particular level of coverage. I do prefer Revenue Protection RP), which gives a protection of revenue loss from yield or price. The insured revenue value per acre is determined in the month of February using the fall futures price times your approved yield times the level you choose, 50% to 85%. The price looks to be high compared to the previous few years at this time.
There are also buy-up programs you can insure to a higher level, which you can speak to your crop insurance agent about. After the price is set, you can feel comfortable selling the amount of bushels you have guaranteed as long as the price is above that average, i.e. if you have an approved yield of 220 and choose 75% coverage you could sell up to 165 bushels.
If you have a total loss, you can use your crop insurance payment to purchase those bushels to fulfill any forward contracts you have made. I would recommend a 75% to 85% level based on your estimated breakeven costs and financial risk tolerance. A harvest price is also determined during the month of October, and your revenue guarantee is based on the higher of the spring or harvest price, so if you lock in a futures price over the spring price, you should be protected.
Plastina: Crop insurance can be used with forward contracts and hedge-to-arrive contracts (HTA) to sell a portion of your crop before harvest to lock in a profit. The starting point of a marketing plan should always be your cost of production per bushel (see Iowa State University’s Ag Decision Maker file A1-20). When December futures prices rise above your cost of production, then you can sell a portion of your unharvested and insured crop to lock in the price.
The best instrument to sell your unharvested crop will depend on your expectations regarding basis (the difference between futures and cash prices). If you expect basis to weaken (resulting in lower cash prices for a given futures price), then you might want to sell your bushels with a forward contract that sets the cash price and delivery date. If you expect basis to strengthen (resulting in higher cash prices for a given futures price), then you might want to sell your bushels with an HTA that sets the futures price and delivery date, but uses the basis of the delivery date to set the cash price.
The number of insured unharvested bushels to sell will depend on your crop insurance choice, cost of production, risk tolerance, and price projections. Revenue Protection covers both yield and price risks, so it is better suited overall than other crop insurance policies for supporting pre-harvest marketing. Also, since RP adjusts the insurance liability upward when (October) harvest prices are higher than (February) projected prices, it provides an extra layer of security if your crop ends up being smaller than projected and you have to buy bushels in the market to fulfill your pre-harvest marketing contracts. The higher the coverage level, the larger the share of your APH (actual production history) that can be marketed in advance. Ag Decision Maker File A2-55 discusses pre-harvest marketing in more depth.
For bushels that you prefer not to commit to delivery, you can still protect your futures price with tools such as futures hedges or buying put options. These tools require out-of-pocket upfront expenses that are not required by the preharvest marketing strategies.
Miller: I have never been comfortable with the popular recommendation to forward contract as much of your crop as you cover with crop insurance (i.e., if you have 65% coverage then forward price 65%). My reason for discouraging that practice is that forward contracts are cash obligations and crop insurance pays based on the CBOT price. So, if crop yields are down over several states, the local price could be higher than the Board price and producers might have to pay the elevator additional money beyond what insurance covers. That happened to our producers in the drought of 2012.
Instead, I recommend that producers first focus on forward-pricing the portion of the crop that is not covered by insurance — in this instance, 35% when at the 65% coverage level. That way they start out with a price floor on all their bushels without being obligated to deliver more bushels than they produce. Once they take that step, they can continue to forward-contract more bushels, but it may be wise to stop at the 50% level of production. If they want to price more bushels beyond the 50% level, then I would recommend buying puts to set a floor under the price, so they are not locked into physical delivery.
I’ve never used hedge-to-arrive marketing before, but am considering it as a marketing strategy for this year’s crop and the upcoming marketing year. How can I use hedge-to-arrive to my advantage? How can I minimize basis risk when using a non-roll HTA, or spread risk when using an intra-year rolling HTA?
Zhang: ISU Extension Ag Decision Maker’s Information File A2-74 has a background description of non-roll HTA and intra-year rolling HTA by my colleague Steve Johnson. Non-roll HTA is typically used when you expected futures prices could go down yet the crop basis might strengthen. Using a non-roll HTA, you lock in a favorable futures price at a time when the basis is fairly wide, based on historical data, and hope that the basis narrows at some point so that you can lock in the basis and establish your final price.
Non-roll HTAs do not eliminate basis risk, they remove price-level risk but involve exposure to basis risk — the risk that the difference between local cash prices and the nearby futures price will move in an adverse direction and lower the producer’s net price received. Basis risk is typically relatively small but can be sizable in times of extreme weather problems, inadequate storage space, transportation problems, and demand shocks.
Spread risk (differences in various futures price delivery months) is not involved with these contracts. If you want to reduce basis risk then just forward contract, which is often used when you expect both the futures prices and basis to weaken in the future. ISU Extension Store File FM101G has a short video on Crop marketing strategy mix that could be helpful as well.
Stout: The non-roll HTA removes price risk but leaves the basis open until you set it. This past fall the basis narrowed at harvest while typically it widens. The best way to minimize basis risk is to know the history of your local basis and use that knowledge to your advantage by locking it in at a typically narrow time. If you don’t know the normal basis throughout spring through fall, at least track it regularly and lock it in when it is at the lower range you have been tracking. If you track the basis regularly for a few years you can get a better idea of that.
Often in the spring the basis will narrow in our area as the river opens up for barge traffic which is another market for corn and soybeans beyond the crushing plants, feeders, and ethanol plants which have a more stable year-round demand. Also, in spring many of us farmers are more interested in planting crops than hauling crops to market which can lower the supply available and also narrow basis, so keep that in mind.
The intra-year rolling HTA adds another factor that you can use to give you more time by adding the option of rolling to a further out futures month. It would be good for you to study the normal spreads from one contract month to the next before attempting this but it will give you a longer period of time in which to determine your final cash price, so in that way could spread out your risk longer.
Miller: I am not a big fan of HTA, unless you have lots of marketing experience. Oftentimes people forget to monitor their HTA contracts and never get a good basis locked in. Thus, when they finally deliver bushels for the contract in the fall, they get hammered by the widest basis of the year. I think you also rob yourself of some marketing flexibility with an HTA contract because you’ve already committed to bringing the bushels to a certain elevator. In fact, if the elevator is offering a forward contract with a reasonable basis, you are just as well off to use that pricing tool.
Some of my producers have used HTA contracts to price the next year’s crop while they are harvesting the current year’s crop. They are choosing HTA at that time because they know the basis is at a very wide level and they think they can lock in a lower basis later. When they are successful with basis monitoring, they usually lock in a narrower basis sometime between April and July. However, basis patterns will vary with locality, so make sure you know what time of year has the narrowest basis for your area.
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