While visiting with producers at winter farm meetings one common theme surfaced: producers want to do better with their grain marketing.
With snow still on the ground, and little chance of an early spring, use this time to sit in your office and brush up on your grain marketing skills! The past decade of volatile, lackluster markets reminds us to take advantage of cash marketing strategies when prices are opportunistic. Having a plan ready now will allow you to pull the trigger on cash sales at appropriate times in 2020.
It’s also a good time to review the various futures and options strategies you can use to protect unpriced bushels should prices fall lower. In the day and age where one “tweet” can move a futures market limit up or limit down, you have to be on your game and ready to take advantage of marketing opportunities. Looking for a place to start this refreshment process? Look no further:
Ways to lock in cash sales
While there is more than one way to lock in a cash sale, let’s keep it simple and focus on the two most popular methods. Let's first look at forward contracting. This is a contract between you and a physical buyer of your grain; the elevator, ethanol plant or processing plant. The forward contract specifies price, time, quantity, and date of delivery. Once you agree to this contract with the buyer you know exactly where, when, quantity, and the final price received of the grain you are responsible for delivering to the buyer.
The potential negative is the inability to benefit from higher prices, should prices increase after you have entered into the agreement.
Another way to sell grain with a commitment to deliver and not lock in basis (the difference between the cash prices and the price in Chicago on the Board) is called hedge-to-arrive. Hedge-to-arrive contracts require a delivery period on a specified quantity of bushels. The futures price is locked in and known, yet this contract leaves the potential for basis improvement in the months ahead.
If your elevator offers hedge-to-arrive contracts, make sure you understand the cost (hidden fees) as well as ramifications if delivery cannot be made.
Ways to protect price ‘on paper’
Sometimes, you may not be comfortable making cash sales, especially if the crop growing in your field appears to be in disarray.
In lieu of cash grain contracts, you can sell futures or use options with a commodity brokerage firm. To do this, you need to open an account, and find a broker that you trust to teach you the ins and outs of different marketing tools, and how to properly use them.
When looking at protecting prices, and giving yourself a price floor, if you do not have a big risk tolerance, then the tool you want to use is “buying a put option.” You pay a one-time premium and commission for the put (no margin calls). If you want to establish a price floor and leave the topside open for cash price appreciation, then buying a put is a great tool to use.
Another strategy is a fence. A fence is a strategy that “fences in a range of prices.” A short fence is where you buy a put and sell an out-of-the-money call. The objective is to reduce the cost of the put with premium collected from the sold call. The sold call is a marginable position, so you will need quick access to cash in order to meet potential margin calls if futures prices move higher (but keep in mind, if the futures price is rallying, likely your cash price is moving higher as well, and you benefit as the cash price on your grain increases).
Lastly, a bear put spread is the purchase of a put combined with selling an out-of-the-money put in the same contract month. While selling a put can help reduce the cost of the long put, it does cap your ability to gain on the position if the futures prices drop.
As a producer, you should question if you really want to cap your long put option value if prices are weak. Yet, if you believe the market can go down only to a specific level, then selling an out-of-the-money put option may be advisable.
If you have a bigger risk tolerance, then you might want to consider selling futures. The potential negative is that you will be required to meet margin calls, which can grow dramatically if the futures price rallies. Unlike a hedge-to-arrive contract where the grain elevators meet the margin requirement (behind the scenes on your behalf), the risk shifts to you, and you will need to have cash flow readily available to finance your account.
Whatever your strategy, make sure it works for you. Understand it and be comfortable with it. Preparation is key to marketing. By pre-planning and being prepared, you'll be many steps ahead of most. As a producer, you must be aware of the tools you can use to shift risk. Don’t bury your head in the sand.
Doing nothing is perhaps the riskiest marketing decision of all.