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Plan market moves ahead

Agriculture.com Staff 04/01/2010 @ 1:55pm

After this week, the market will have the Acreage and Stocks report behind it and focus on weather. Like it or not, for the next 3 to 4 months, price activity will be more biased on what weather provides than anything else. We have heard a lot of producers as of late suggest that prices could continue to move lower. That is the likely scenario if weather is near ideal. However, the U.S. does not have enough inventory, nor does the world, to withstand a weather disruption. We encourage producers to plan ahead regardless of weather conditions for this year's crops.

So how do you plan ahead? Our first bias is to encourage farmers to recognize that, in any given year, prices generally work in a range. In our opinion, the December corn futures will have a range between $3 and $5, and November beans between $7 and $12. We also think it is prudent to assume normal crop conditions until proven otherwise, which means a defensive mindset. This year, the markets have already moved into a downtrend, but it may have much further to go depending on crop conditions. Therefore, moving into late spring and early summer, we think it is advisable that farmers forward contract enough corn and beans to be comfortable. Our bias is to forward sell anywhere from 25% to over 50%. With the advent of insurance products, which most farmers use, the ability to be a more confident, aggressive forward contractor is greater than any other time in history. For bushels you do not intend to forward contract, we encourage the use of put options. Purchasing a put establishes a price floor. A more aggressive strategy is to purchase puts and sell call options. This strategy, also known as a fence (or in some instances a min/max contract), can provide a price floor at a cheaper rate than an outright purchase of a put, as long as the call option which is sold loses its value. In addition, you can purchase puts for crop that is not forward sold. Make sure you understand the risk parameters with this position.

If weather were to prove uncertain, or it looks as though there may be a shortfall of production, prices could rally significantly. By being upwards to 50% forward sold and puts bought on 50% of the crop, you now can participate in a rally on half of your expected production. If you want to cover bushels that have been forward sold, buy call options. We suggest one of two calls. Either ante up and spend money for an at-the-money call, or go out of the money enough that you are not spending as much money. You now own a safety valve. As a reminder, a call option gives you the right to own, but not the obligation. In essence, one way to view a call option is as an insurance policy against higher prices.

If the last two years have taught us anything, it is that volatility can come to life in virtually no time. Weather is the most dominant factor that determines whether a corn crop will be 7 billion bushels or 13-1/2 billion. Are you prepared for either scenario?

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