Many commodity markets are experiencing unprecedented volatility and the corn, wheat, and soybean markets are no exception.
Historic volatility continues to engulf prices and farmers are challenged to navigate through myriads of information while attempting to make good marketing decisions.
You are a producer, and your goal is to produce a great crop and sell it at the best price possible. Yet, what is the best price? You will only know this with the benefit of hindsight. If nothing else, monitor the market and sell into rallies. In a year like this, any sale can look like one that should not have been made since prices continue to reach new highs (due mainly to extreme events).
Time for a reality check. Most, if not all, farmers cannot hold inventory indefinitely. And the longer you hold inventory, history would also suggest it is a matter of time before prices decline, often violently. Yet, emotion can often take over and cause you to freeze when you know you should be making sales or cause you to make decisions that are not necessarily thoughtful. This is where putting energy into strategy rather than outlook can help.
In volatile times we suggest keeping it simple. Continue to reward rallies. Often sales are made because price is good, but too often hesitation occurs because they are good for a reason. Small sales are made and well, sometimes that is it. If prices drop, regret sets in that you didn’t make more sales. Or, there may be other reasons to make sales such as limited storage space, cash flow requirements, or logistical need to move product.
In a highly volatile environment, if you reward the rallies and feel you will have significant regret if prices continue higher, then you need to re-enter the market. A suggestion is to use fixed risk call options which give you the right to own futures but not the obligation. Options are bought and sold daily by the Chicago Board of Trade and are, in most cases, liquid (many buyers and sellers). In high volatility, option prices increase in value because the seller is taking on the unlimited risk. Recognize this increase to option cost is reflective of opportunity for you to sell cash grain at higher values.
If you do choose to retain ownership with future contracts, recognize you have unlimited risk unless you use stop orders that are trigger points beneath the market which, when elected, sell your contract when the market touches or goes through the stop price level. In volatile markets, the risk you run using stop orders is that the market drops to a point that triggers your order, you exit, and then prices rally. If you choose not to use stop orders, your risk is unlimited. Perhaps the only time to use future contracts to own sold grain is when you are up against a timetable: You must move your grain out of storage, but you really don’t want to sell. In essence, when buying future contracts, you are willing to take the same price as though you had actual inventory less any potential gain or loss from basis.
Forward contracting is an attractive tool as are hedge-to-arrive contracts. These do require delivery, so you need to be careful on how much you’re willing to sell in advance of harvest. Yet, taking advantage of high prices and adding a long call is a strategy to allow you to make sales rewarding a price rally, and yet able to participate if prices move higher. Another strategy to protect against lower prices is to purchase a put option. This is a fixed risk strategy subject to the costs associated with the put while leaving grain unpriced. The key is to act.
History suggests strong gains are usually short-lived.
If you have any questions on this Perspective, feel free to contact Bryan Doherty at Total Farm Marketing: 800-334-9779.
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.