I’ve been fortunate enough to serve farmers’ risk management needs for 37 years. I have seen volatile markets before, and there are lessons to be learned from past volatility during these trying times.
The grain and livestock markets were already dealing with negative news before COVID 19 hit. Losing further demand is a crushing blow to price. Can commodities separate themselves from the collapse of the financial markets? Can you afford to find out the answer is no after doing what you currently are doing to defend price?
Make good decisions but be timely
What can you do regarding the price risk on the various commodities you are involved in? My advice on your first move is to see this as a potential crisis and have a plan in place to survive.
The problem with a crisis is, it is an impossible situation to study forever and you don’t have time to wait to see how it will end. Decisions are either already made, will have to be made fast, or will be made for you if no action is taken.
My sense is grain growers are ready to focus on planting season and hope all the crazy in the world subsides by the time they finish. Let’s hope this is true, but I wouldn’t count on that plan working.
Fear the worst-case scenario but be ready for the best case as well. For almost all of you the risk is lower prices and the inability to show a profit. We are at that level today for many. Focus on what you can do to stop things from becoming worse for your operation. Many commodities are valued at below break-even prices. However, long put options on your expected 2020 crops will stop the bleeding at some level but IF we see prices increase, you will have the opportunity to reward any rally.
What about the 2019 bushels you have not sold? Basis levels are very good in most parts of the country and the futures carry on corn and soybeans is not enough to justify maintaining cash ownership. Sell these bushels and purchase long call options on the bushels sold. Once executed you can have some control on price, and you can still root for higher prices via the long call ownership.
Options: right for today
You can’t stop price from being too low, but you can stop it from getting worse. This isn’t a fun place to be but it’s where things stand for now. I sense most everyone has the expectation for time to solve price issues. That’s not a plan. That’s just a hope. Some people like to dismiss options, but they are the right fit, especially for today. Forget where price has been and stop it from getting worse by purchasing put options today on unsold bushels. It won’t lock in a profit but at least you now control price if we continue to move lower.
The beauty of buying a put and locking in price is the ability to cheer for higher prices without being in endless pain if we continue lower. Price protection will allow you to make better decisions going forward and knowing the worst-case scenario will lessen emotional reactions.
There is nothing enjoyable about beginning your marketing plan with a floor price of X cents per bushel below breakeven, but it is a better choice than eventually selling at 5 times below your cost of production. It’s about survival. Please remember this is a worst-case scenario floor price with the ability to increase it if price improves.
I sometimes hear people attack options’ effectiveness. But show me one example of an option not performing exactly as it was intended to do so at the time you purchased it? They work if you know how to combine them with cash forward sales, managing carries and basis.
Is the information you count on helpful?
Examine your biases and control from where and from whom you plan to receive input and information. It’s normal and expected that you will seek out people and information that aligns with what you want and need to happen. In fact, to be a solid price risk manager, it is a good thing to be told things that challenge how your marketing plan is currently structured.
The best marketing plans prevent the risk before it happens. The second-best plans do what is best today. Don’t look back, look forward. If you didn’t prevent risk, now is the time to stabilize the situation by establishing worst case minimum prices with the assistance of the options market.
Let's get the old crop bushels sold and replace the ownership with long call options. This will help control your marketing worries as well as can be done today. This will allow you to make future decisions based on calm, unemotional opportunities surrounded by your team without price bias. Calm comes with control of price.