At this writing, wheat may be forward contracted for harvest delivery for $6.15 (-15 basis) in Medford, Okla.; $5.95 (-35 basis) at Perryton, Texas; and $6.00 (-30 basis) at Snyder, Okla. At this same date in 2020, the forward contract prices were $4.70 (-30 basis) at Medford, $4.65 (-35 basis) at Perryton, and $4.55 (-45 basis) at Snyder.
Forward contracts are a relatively good and safe method to lock in a price. The process is as simple as signing the contact and delivering the product.
Another method to consider is using put option contracts to establish expected minimum prices. KC July put option contracts expire June 25, 2021, and KC September wheat options expire Aug. 27, 2021. At this writing, the KC July wheat contract price is $6.30, and the September wheat contract price is $6.33. The $6.30 July put premium is 42 cents, and the $6.30 September put premium is 52 cents (5,000 bushel contracts).
Buying a put option will “lock-in” a futures contract price, but not the basis. So, the “minimum price” is and “expected” price. The difference in the actual basis and expected basis will cause the actual minimum price to be different from the expected price.
To estimate the expected minimum price, a minus 25 cent basis will be used for the KC July contract, and a minus 35-cent basis will be used for the KC September contract.
At this writing, buying a KC 620 July put would create an expected minimum price of $5.63 (630 – 42 cent premium – 25 cent basis). Buying a KC 630 September option would yield an expected minimum price of $5.43 (630 – 52 – 35).
The put option premium cost may be reduced by buying an “out of the money” option. A KC 560 July wheat put option premium is 18 cents, and a 560 September put option premium is 22 cents. The expected minimum prices are $5.17 (560 – 18 – 25) for the KC 560 July put and $5.03 (560 – 22 – 35) for the KC 560 September put.
If you are pricing, especially forward contracting, an important question is, how many bushels will you harvest?
A rule of thumb for some producers is to forward contract up to 50% of expected production. By definition, actual production will be above expected production 50% of the time and below expected production 50% of the time.
Setting expected production for the 2021 wheat crop is a combination of current crop conditions and the weather forecast. Except for an area in extreme south central Kansas and most of Oklahoma, the hard red winter (HRW) wheat production area is in drought conditions.
Except for South Dakota and farther north, the (February through April) forecast is for above average temperatures and below average precipitation. The current soil moisture condition and the forecast imply that the odds of having below average yields may be higher than normal.
A good method to forward price is to stagger sales. For example; expected production is 40,000 bushels, and 20,000 maximum will be forward priced. The 20,000 bushels could be priced in four lots of 5,000 bushels. The first 5,000 bushel lot could be priced at the current price, with each additional 5,000 bushel lot priced at 25 cent price increases.
When finally making a decision, one criteria to use would be to make the decision that lets you sleep at night. If you lay awake because you’re worrying about having to sell at a lower price, price some wheat. If you lay awake worrying about not being able to take advantage of higher prices, use puts or do not price.