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Corn+Soybean Digest

Protect Your Position

With a huge national cotton crop expected to again hold prices below the 52¢/lb government loan level, most growers from North Carolina to New Mexico will be content with a marketing plan that consists of government payments generated from the new farm program.

But some, like Seminole, TX, grower Steve Bell, are also positioning themselves to bank a few more cents in the event of unexpected market swings upward.

Bell's biggest concern is protecting his counter-cyclical payment (CCP) on about 900 acres of dryland cotton that succumbed to drought and hail this year. Even though he won't sell any of his failed 2002 crop, he wants to pocket that CCP, which is decoupled from actual production in the new farm program.

A sudden and sustained increase in cotton prices could offset any CCP next year, even though prices are looking low at harvest time. He's counting on call options to do it.

The farm program's CCP rate is based on the target price, minus the direct payment, minus the greater of a 12-month average price received or the loan rate.

For cotton, that translates to about a 72¢ target price, minus about a 6¢ direct payment, minus the 52¢ loan rate, since prices have remained well below that level for months. Thus, the CCP is about 14¢ on average yields from 85% of the base acres.

If prices rise above the loan rate, and stay above the loan rate, the amount of government payment is reduced because of a narrowing between the average price and the target price. For those harvesting a crop and storing a crop, that is made up with the higher price. But the would-be CCP is lost or reduced for growers like Bell who face crop failure.

Figuring an average yield of about 300 lbs/acre, that 14¢ equates to over $40 for every eligible acre he wants to secure. To protect the CCP, Bell bought 52¢ March 2003 call options to cover any unexpected jump in prices. His purchase price was only about 1¢/lb. “We know that it will require a major disaster or weather rally to push prices up, but we still want that CCP protected just in case,” Bell says.

Mississippi State University's O.A. Cleveland feels there is little chance the 52¢ loan level price will be surpassed for any lengthy period, especially with the large projected crop of 18.4 million bales. “It's doubtful that growers will lose any of the '02-'03 CCP,” says the cotton marketing specialist.

“The average spot price received by growers from Aug. 1, '02 through July 31, '03 would have to average above 52¢/lb. With the bulk of marketing occurring between November and January, prices to growers during that time period would have to be near 52¢,” Cleveland says. “That would imply a December futures price of about 58¢ or better. Anything can happen, but probably not that quickly.”

Carl Anderson, Texas A&M University cotton marketing specialist, along with Cleveland, are among the nation's most respected cotton marketing authorities. Neither is quick to guarantee a price, but they don't mind recommending possible marketing strategies.

“The challenge in ‘hedging’ the CCP is in estimating the futures price level and movement for the marketing season,” says Anderson. “If supplies increase and prices remain well below the 52¢ loan rate, there's little concern that the CCP will be reduced.”

Nevertheless, if growers are interested in covering the CCP, Anderson has some suggestions for next year's crop.

“Because about half the season's crop is marketed August through December, the practical approach to protecting the 52¢ benchmark price for reducing CCP is to first hedge using December calls. When hedging for the '03-'04 season, December 2003 futures could be used.

“A strike price around 54-58¢ is a reasonable level when considering the potential variation in relationships of farm price and futures. The difference in price is for the season's average price received and not the price received by individual growers.

“So, a December call strike price of about 56¢ could be used alone, or, to reduce premium costs, a 56¢ call and the selling of about a 62¢ call would provide some protection. But the 62¢ call would place a ceiling on income gained should futures price exceed 62¢, unless the positions are changed,” Anderson says.

Bell notes that if in the spring of '03, the price escalates to the 50¢ range or even 60¢, he might again go as far out as March '04 with call options. He'd pay up to 3¢ for them, especially if he loses the crop or plants another crop on the cotton acres. “Your CCP will be protected,” he says. “If prices go back down, you just deduct that 3¢ from your CCP. At least you know you will receive that amount no matter what happens.”

Anderson warns that producers who are likely to exceed CCP limits of $65,000 and those that plant cotton base in another crop should consider ‘hedging’ CCP payments to protect cash flow against higher prices above the 52¢ loan rate.

Kenneth Paxton, a Louisiana State University extension economist, says growers should always consider taking advantage of marketing strategies that will help them generate or maintain a price. “You always want to utilize the market to protect yourself,” he says.

Bell stresses that he would prefer using hedges to protect a higher price, especially when he has a good looking crop that will yield.

“It's a lot easier to hedge from the high side,” he says. “When the opportunity is there, we try to use futures or put options to secure a solid floor price. A few years ago we sold 70¢ December futures to protect that price. I just hope we can take that type of strategy again soon.”

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