It is early June and baseball season is in full swing. One of my favorite baseball movies is “For Love of the Game”. In this movie, Kevin Costner plays the part of an aging pitcher for the Detroit Tigers pitching against the New York Yankees in New York. As Costner is on the mound and gets ready to throw against the first batter, he hears the jeers of the crowd and all the other noises from the stadium. One can only imagine how loud New Yorkers can be when yelling at an unwelcome out of towner.
Before Costner throws the first pitch, he says to himself, “Clear the mechanism." At that point, all the noises fade away and the crowd becomes blurred. It is just the pitcher, catcher, and the batter. The game is brought back to its simplest form so the pitcher can focus on what is important at that moment and on what he can control.
I had a conversation with a grower recently that relates to this scene at a crowded baseball game. His comment was, “I listen to so and so and they say corn prices are going to shoot to the moon due to XYZ. I listen to another person and they say acres are going up significantly and price is going to drop. I don’t know who to believe.” The grower is hearing those screams and shouts of people in the crowd telling him multiple directions that prices can go. When hearing all this noise it can cause paralysis to make any decision at all. We all know not taking action is a decision itself.
Simplify the game
When situations get complicated, we can concentrate on what needs to be done by focusing on the fundamentals. Producers have two fundamental risks that need to be taken into consideration for the product they are selling. The first risk is if the market goes down. In most cases this is the growers’ largest risk as lower prices will typically lead to lower profitability, loss in position on balance sheet, and weaker cash flow. The second risk to the grower is if the market goes higher after pricing the product. This lost opportunity to capture higher prices can lead to missed profitability. We think about what our balance sheet and cash flow could have looked like if we captured those higher prices.
Now that we have identified the risks to our operation, what can we do to mitigate those risks? To protect against a market decline but maintain flexibility for higher prices we can look at two different tools to use. We can:
- Make sales and protect upside by buying a call option. There are a variety of ways that one can decide how to sell, but in its simplest form, a sale will protect you from a market decline. If you sell corn at $6 and the market declines to $4, you can sleep at night knowing you have the bushel sold at $6. If the market goes from $6 up toward $8, the call is a tool that can help you capture some of this price increase.
- Buy a put option on unsold grain/livestock. A put helps to establish a floor in case the market goes lower. It serves as a jack stand to help you keep your average price propped up on unsold product in case of a market decline. You are able to participate if the market goes higher because the product is not yet sold.
As with many tools you have around the shop, if used correctly they can be very helpful and allow you to accomplish good work. If used incorrectly, you can get hurt. Also, if you buy a tool and stick it in the toolbox, it will not be helpful. Make sure you look for good resources to help you learn how to use the tools and the risks associated with them.
In this volatile price environment, remember to “Clear the mechanism.” Don’t let the chatter of the markets paralyze you and prevent you from making decisions that will help you capture profitability and maintain flexibility.