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Many farmers combat a volatile market and low prices by developing hedging strategies to mitigate risk. When it comes to developing a strategy there's no one answer that works for everyone. Use this page as a resource for learning more about basic marketing terms, and don't forget to consult your advisor when determining which strategies are best for your farm.
The first step towards creating an effective marketing plan is understanding your cost of production. This means more than just estimating what it costs to run your operation. It means knowing how much it costs to produce each commodity. While it can be time consuming to gather the information necessary to truly understand your cost of of production, doing so is a valuable investment in the future of your farm.
Knowing your cost of production helps you calculate your break-even price, the price you need to sell your grain at to cover the costs of growing it.
We surveyed over 1,000 U.S. growers to identify crop marketing trends in the face of today's low commodity prices.
Growing your crop efficiently and producing great yields is only part of what it takes to keep your farm in business. The other part is making sure you sell your crops at a price that covers your costs and makes a profit. Diversifying your crop marketing plan is similar to having crop insurance: you want to protect the investment of capital, time, and hard work your put into growing your crop.
It's not news that corn prices have been at historic lows, and it's taking a toll on U.S. farms. By looking at corn price trends year-over-year, we can see that prices are higher during the growing season and lower during harvest. It's estimated that two-thirds of farmers are selling in the bottom one-third of the market, meaning those selling their grain during harvest aren't taking advantage of higher prices available at other times in the year.
Hedging is a great way to mitigate risk, as cash market and futures market prices tend to move up and down together. Hedging is a way to lesson your risk through offsetting your cash position by having an opposite position in the futures market.
Another important piece of developing a diversified marketing plan is knowing what's going on in the market. There are a lot of great market newsletters you can subscribe to, and don't forget, you can always consult with an advisor!
Dave S. is a 52 year old farmer who helps run his family's grain and livestock operation in Wisconsin. In this articles, he addresses some of the biggest hurdles that farmers face when it comes to crop marketing, and why diversification is the key to running a profitable farm.
A futures contract is an agreement to buy or sell a specific amount of grain delivered to a set location on a set date and for a fixed price. Futures contracts are standardized, which means that the quantity and quality of the product is established, helping eliminate risk for both buyers and sellers.
Futures contracts are created by and traded on the exchange. The exchange is responsible for specifying a contract's details and ensuring that the contract will be honored.
Futures contracts are often referred to by their deliver date. For example, if you had a futures contract for corn in March, this would be referred to as a March Corn Contract.
The price for a futures contract is determined through price discovery, which happens when buyers and sellers interact in the market. You can think of price discovery like supply and demand.
Futures contract codes
Futures codes are typically three to five letter codes that indicate the product, month, and year of the contract's expiration. Below, you'll see a list of contract month codes:
January = F
February = G
March = H
April = J
May = K
June = M
July = N
August = Q
September = U
October = V
November = X
December = Z
Example: A corn futures contract that expires in December of 2019 would be CZ9.
The short hedge allows you to protect the price you can get for your crops come harvest by selling a portion of your bushels now on the futures market and buying them back later when you are ready to sell in the cash market. As a producer, you will always be considered "long" as you have grain to sell, so a short hedge helps offset a loss you may have from a decline in the cash market price.
Example: It's June and you're a corn farmer with your crop in the ground. You know that right now, the cash price for corn delivered in October is $3.50/bushel. Hedging a portion of your bushels through a short futures contract would help you offset the risk of prices falling come harvest, because a decrease in the cash price will result in a grain on your futures position.
Cash Market = $3.50/bu
Futures Market = sell at $3.50/bu
Cash Market = $3.00/bu
Futures Market = buy at $3.00/bu
Gain / Loss
Cash Market = $0.50
Futures Market = $0.50
A long futures contract allows buyers of agricultural products to protect from price increases if the market moves upward. Rarely, producers will purchase long futures if they believe the market is moving up and want to participate in capturing additional upside potential.
Basis is the difference between cash and futures prices. Transportation costs, grain availability, and other factors contribute to basis, which is why the price you see on the exchange is different from your local cash price.
A basis is "strong" when it causes the cash price to be higher than the futures price. A basis is "weak" when it causes the cash price to be lower than the futures price.
If you're buying or selling in the futures market, you'll be required to deposit money with your broker. While there are minimum levels that the exchange has established, your broker's firm will determine the amount of money needed for deposit.
Margins are used to ensure the performance of your contract. If you have a short position and changes in the market causes the futures price to increase, you may be required to deposit more money, which is referred to as a margin call.
Both forward contracts and futures contracts can be used to mitigate risk. With forward contracts, you agree to sell a specific amount of grain for a fixed price to a buyer in the cash market at a future date. Futures contracts are traded through a broker on the exchange, and your final cash price may change depending on basis. Whereas forward contracts can vary in size, futures contracts are standardized by the exchange. For example, futures contracts for corn, soybeans, and wheat are traded in lot sizes of 5,000 bushels.
An option is the right, but not the obligation, to buy or sell a futures contract for a specified price within a certain range of time.
There are two types of options: calls and puts. Call options give you the right to buy an underlying futures contract. Put options give you the right to sell an underlying futures contract. Keep in mind, both calls and puts have buyers and sellers. Buyers are buying the rights of an option, and sellers are selling those rights.
Option buyers must pay a premium to the sellers to get the rights of that option.
Example: You are a soybean farmer and suspect that prices will decrease before you can sell your soybeans. You could buy a put to set the floor price of your crop. If prices were to increase, you wouldn't have to exercise the put option, because you would want to take advantage of the higher prices to sell your soybeans.
Alternately, you are a livestock feeder who needs to purchase corn, but you are worried that if prices increase you won't have enough cash to make the purchase. Buying a call options sets a cap on the maximum you'll pay for corn. If prices fell, you wouldn't have to exercise the call option, because you would want to take advantage of lower prices to purchase your corn.
Options are made up of four key components:
Strike price (or exercise price) on an option is the price at which you can buy or sell an underlying futures contract. The exchange sets the range of strike prices for futures contracts.
Strike price is not the same as the premium that the buyer of an option pays to the seller. The premium paid simply gives the buyer the ability to exercise the rights of that specific option.
While you'll only ever see the total premium value, premiums are calculated by adding together the intrinsic value and extrinsic (time) value.
If exercising an option is profitable, an option has intrinsic value. For a call option that means the strike price is greater than the underlying futures price. When an option has intrinsic value, it's referred to as "in-the-money".
When an option does not have intrinsic value it's referred to as "out-of-the-money". For a call option, that means the strike price is below the underlying futures price. For a put option that means the strike prices is above the underlying futures price.
If an option doesn't have intrinsic value and hasn't expired, it has time value. This is because there's still a chance the option might become in-the-money before expiration. The time value is determined by subtracting the intrinsic value from the premium.
A call option gives you the right, but not the obligation, to buy an underlying futures contract at a fixed price. If the market moves up by more than the premium you paid, you can buy the future at the strike price and make a profit. If the market goes down, you are not obligated to buy the future by exercising your call option.
A put option gives you the right, but not the obligation, to sell an underlying futures contract at a fixed price. If the market moves down by more than the premium you paid, you can sell the future at the strike price and make a profit. If the market goes up, you are not obligated to sell the future by exercising your put option.
There are three ways to exit an option position: offset, exercise, and expiration.
If your option has value, you can offset it by selling or buying a put or call that is equal to the one you originally bought or sold.
If you choose to exercise your option (only buyers can do this), it will create a new futures position at the strike price. The only time a buyer would exercise an option is when it has intrinsic value (in-the-money). For a call, that manes the strike price is below the underlying futures price. For a put, that means the strike price is above the underlying futures price.
If the option has value at expiration, it will be exercised. If it does not, it will simply expire, and the only loss you'll incur will be the price of the option's premium.
Cash contracts are those which happen on the cash market, and are typically negotiated with your local elevator. While these contracts won't require margin call, there is usually a per bushel fee.
A forward contract is an agreement to sell a specific amount of grain for a fixed price to a buyer in the cash market at a future date. Both the futures price and the basis are locked, and while you won't have to worry about a margin call, there is a per bushel fee charged by the elevator (usually 2-3 cents).
Hedge to arrive contracts lock in the futures price while leaving the basis open. With an HTA, you are agreeing to deliver a specific amount of grain to a set location on a fixed date. There is usually a per bushel fee charged by the elevator (usually 2-3 cents).
Basis contracts lock in basis while leaving the future price open. With a basis contract, you are agreeing to deliver a specific amount of grain to a certain elevator on a fixed date. Oftentimes, basis contracts don't require a fee.
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REFERENCES & RESOURCES
The information on this page is purely for educational use. FarmLogs is not a stock or commodity advisor. FarmLogs does not advise or offer advice on planning for or executing on marketing strategies. Always consult with your advisor before making marketing strategy decisions. Information on this page is derived from many sources and may not be complete.