TOP FARMER WEEKLY PERSPECTIVE 2/5/2021 BY BRYAN DOHERTY

Revisiting a Balanced Approach

As 2021 unfolds, attention turns to marketing the upcoming crop. The last several months have commodities experiencing volatility not seen since the drought of 2012. Increasing demand and decreasing supply are the two primary reasons, coupled with uncertain weather, currency fluctuation and concerns with Covid-19. With high volatility comes opportunity and risk. Trying to outguess the next six months and how prices will fluctuate could be a difficult task. In this Perspective, we will discuss a balanced approach and how this can help to manage the uncertainties in the year ahead.

In most years, crop production is good enough to create increasing supplies by fall; consequently, lower prices. The goal is to shift risk of the crops you are producing well before fall. This approach assumes normal production and has you forward contracting up to half of your expected production during the mid-winter to end of spring window. The other 50% of expected production that is unpriced is vulnerable to downside price risk. Protect the value of these bushels by purchasing put options. The owner of a put has the right (not obligation) to exercise the put into a short futures at the purchased strike price. The risk you incur through purchasing a put is in the premium you paid plus commission and fees. Using a put establishes a price floor. By harvest, if the put option has value, you can exercise it. If you are selling grain across the scale, sell the put. The bottom line is that between forward contracting 50% and purchasing puts on 50% of expected production, you have protected 100% of your anticipated production.

What if prices rally? The 50% of bushels protected by puts can participate in a price rally. The 50% that is forward sold is a locked price and cannot increase in value.  So how can those bushels participate in a rally? Purchase call options against the forward sales.  You have the right (not the obligation) to own futures. This means that if prices rally, the calls can gain value and ultimately add to forward sales. If prices drop, your risk is fixed to the cost of the calls, commission, and fees. The key to a balanced approach is being prepared for whatever summer weather brings. If prices skyrocket, you are positioned long on 100% of expected production. If weather is great and big crops occur, you have 100% of your expected production covered against declining prices.

There are costs associated with using options. Be well informed of the costs and risks associated with using this strategy. Doing nothing is also a strategy that may be the riskiest, as it is an extreme. You are either 100% right or wrong. Have a conversation with your advisor who can help you to implement a balanced approach, so you are using the right tools for your tolerances at the right time. The year ahead looks promising for more volatility. Disciplined preparedness to execute a balanced strategy is highly suggested.

If you have comments, questions, or suggestions, contact Bryan Doherty at Total Farm Marketing. You can reach him at 1-800-top-farm, extension 300.

Futures trading is not for everyone. The risk of loss in trading is substantial. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Past performance is not necessarily indicative of future results.

Author

Bryan Doherty