TOP FARMER WEEKLY PERSPECTIVE 9/4/20 BY BRYAN DOHERTY
Time to Use a Balanced Approach
A balanced approach in grain marketing is where you are prepared for the market to move in either direction. Marketing is an elusive and difficult challenge for many farmers. However, we think it can be made somewhat easy through a simple process called a balanced approach. This approach includes a combination of cash sales combined the purchase of both puts and calls. The idea is that whether the market moves higher or lower, you are shifting downside price risk while able to participate in price rallies.
Since August 12, corn prices have rallied $0.44 and soybean prices $1; no small amount for either commodity. Futures have moved higher for a variety of reasons. In the end, those reasons may matter little, as the market will continue to find direction, either up or down. It doesn’t take a vivid imagination to anticipate prices quickly giving back most of their recent gains; or for weather concerns and short covering lead to further price advances. The year 2020 has been challenging and, by some standards, a strange year. The market has had to deal with two major Black Swan events, COVID-19 and an energy price war, not to mention an intense windstorm that wreaked havoc on a portion of Iowa’s crops. Prior to that, ethanol waivers and African swine fever, reducing half of China’s hog population, hampered demand prospects. Trade wars lead to trade deals, yet the immediate reaction was muted or even negative, as details were unclear. Recent developments on the trade front with China are more positive, as both sides have recently talked and indicated Phase One is on track. Dry weather throughout parts of the Midwest during the entire month of August has led to crop downgrades after record yield and production estimates on the August 12 Supply and Demand report. Bottom line, there are too many variables to outguess in order to establish a definitive bias for price direction.
Instead, focus on strategy. Consider rewarding this latest price rally by forward contracting up to half of your crop. On the other half, buy at-the-money put options to establish a price floor. Currently, for the corn market, consider buying December $3.60 corn puts; in soybeans, buy November $9.60 puts. Purchase call options on 50% to retain ownership of what was forward sold. Use December one-strike-price out-of-the-money calls for corn and in soybeans buy a one-strike-price out-of-the-money call, based off November futures. You have now put yourself in a position that is well balanced. If prices sell off, the forward sales and puts have shifted risk on 100% of your expected production. If prices rally, your call option can gain value that your forward contracts are unable to, and the 50% that is not priced will gain value. You are in a 100% ownership position.
Once placed, you’ll need to manage this position. Managing capital in options may be less taxing than trying to manage an entire crop and outguessing where the market may go. Either you never have enough downside price risk protected, or you have too much. Speak with an experienced advisor who can help you achieve your goals, monitor the positions, and guide you through the decision-making process. If the markets have done nothing else this year, they have reminded us that unexpected events and occurrences happen, and prices react. Volatility is likely to increase soon. The key to be is to be strategically prepared, formulating a balanced approach to your marketing.
If you have comments, questions, or suggestions, contact Bryan Doherty at Total Farm Marketing. You can reach him at 1-800-top-farm, extension 444.
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