Deep dive: Why hedgers are singing the blues

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Those who held on to grain after harvest, whether in the bin or on paper, were the big winners -- at least so far.

Prices for 2020 crop corn and soybeans turned out a lot better than most people expected before harvest. That includes growers following traditional seasonal hedging strategies, who likely earned a lower net price than their neighbors who did nothing.

Putting on hedges during the spring and summer was a drag on revenues, according to my long-term study of selling strategies. Locking in a price, whether with futures, options or average price contracts, led to lower net revenues than just moving the grain across the scales off the combine. Those who held on to grain after harvest, whether in the bin or on paper, were the big winners -- at least so far.

The unusual 2020 rally – and mediocre yields – made this year the exception that proves the rule. Preharvest hedges continue to offer better long-term average returns compared to the harvest price. But years with rallies later in the marketing year show the risks of relying too much on seasonal averages that work most – but not all -- of the time.

To leg or not to leg

To see how different tactics fare, the study looks at options, futures and cash prices from 1985 to 2020, figuring returns at 11 locations for corn and nine for soybeans. The study assumes hedges are put on during the second week of April and third week of May for both crops. For corn, the last week of June is also included, with the third window for soybeans coming in mid-July.

In addition to sales with futures or hedge-to-arrive contracts, two types of options trades are included. The first is buying put options during the seasonal triggers, and the second analyzes legging into sales by covering short futures/HTA positions with call options purchased during periods of typical seasonal weakness in new crop markets at the end of February, April and May.

In theory, buying calls on weakness should make them cheaper, an important consideration because most calls expire worthless.

This buy call/sell futures trade is known as a synthetic put, because it mimics options that convey the right to sell futures at a predetermined strike price. But like other marketing strategies in 2020, legging into a synthetic put didn’t work either, producing a larger loss than just buying a regular put option.

Owning options as part of a marketing plan in 2020 did have some benefits: It reduced losses for those who just sold futures or HTAs outright. Soybean calls, for example, did earn a return due to the big rally by November futures. But the calls’ gains were far less than the losses suffered by the hedges’ short positions.

The upside of options

On average, for example, the short futures/HTA positions netted $1.84 a bushel less than the harvest soybean price, compared to a 99-cent deficit for a put option and $1.39 loss for a synthetic put.

Besides options, another way of trying to mitigate the vagaries of the market also faltered. Average price contracts based on daily closes from Jan. 1 to Sept. 1 and March 1 to Sept. 1 lost less than a straight futures sale but still incurred red ink of $1.62 and $1.77 respectively for soybeans. The 39-cent loss for average pricing new crop corn during the Jan. 1 to Sept. 1, 2020 window was best performance of any strategy studied for that crop.

The early pricing window for soybeans beat the harvest price nearly three of every four years studied, the same as the futures/HTA sale, though average returns were less.

Despite lackluster performance in 2020, options strategies can be useful in some markets because they avoid staggering losses incurred by both futures/HTAs and average pricing methods. Those negative returns topped $3 a bushel for corn in 2012, when poor yields exacerbated lower revenues from hedging losses.

New crop corn pricing strategies

New crop soybean pricing strategies                                                                                                                                                

Results are based on futures and options settlements and cash prices during 1985-2020 crop years. Revenues are weighted by statewide yields, taking into account gains and losses from yields being more or less than expected, assuming 100% of normal yields are sold on dates indicated. Harvest dates varied according to date 50% of crops are harvested in weekly crop progress reports. Brokerage commissions figured at 1 cent per bushel.           

Knorr writes from Chicago, Ill. Email him at brycemarkets@gmail.com
The opinions of the author are not necessarily those of Farm Futures or Farm Progress. 
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