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3 steps to manage grain market risk in 2014

The extreme price moves the last two years have given me two textbook examples of how my three-step risk-management plan works. I learned a lot about margin calls and rolling up put options in 2012. In 2013, the hedges worked great, and the puts helped protect income.

In both years -- 2012 was the year of the a huge bull market in grain prices; 2013 was the year of the huge bear market when grain prices collapsed -- my three-step risk-management plan worked to protect my corn and soybean income.

For the last five years, I have recommended this three-step risk-management program for corn and soybean farmers.

  1. Buy the appropriate crop revenue insurance policy for your farm. I’m not an agent and do not give advice other than to encourage you to work with a qualified professional who specializes in crop insurance.

  2. Get the insured bushels (the A bushels) hedged ahead.  Depending on the price and profit level you are able to lock in, get 40% to 80% of your A bushels locked in.  

  3. Get the uninsured bushels (the B bushels) protected with puts. Unless you get 100% of the A bushels hedged, consider buying puts on the remaining A bushels.

A quick review

Let’s review what happened in the drought of 2012, when prices exploded higher into the fall of 2012, and the bear market year of 2013, when prices fell lower into harvest.

In 2012, many of you ended up with lower yields and a large crop insurance claim. This was especially true if you were in the area where the summer drought reduced your yields. The crop insurance checks allowed you to break even and to stay in business. If you hedged too many bushels ahead or you tried to save a few dollars by going for the harvest price exclusion, you discovered that was a huge financial mistake.

In  2013, nationwide yields improved for corn and soybeans, and prices collapsed lower into the last quarter of 2013. If you purchased the higher level of crop revenue insurance and had the A bushels hedged ahead and the B bushels protected with puts, you had a profitable year. If you went for a lower level of crop revenue insurance and didn’t get the crop hedged ahead or protected with puts, you were hurt. If you sold aggressively ahead in 2012 and then sold nothing ahead in 2013, you were hurt.

The lesson from the last five years is to stay consistent.

What to do in 2014

This will be a much more difficult year to lock in good margins than last year.

At the time of this writing, I don’t have the average closing price of December 2014 corn futures and November 2014 soybean futures, so I will write up this example with my estimate of what those prices will be: December 2014 corn futures at $4.50 and November 2014 soybean futures at $11.20. This would be down $1.15 per bushel on corn and $1.67 per bushel lower for soybeans.

Following is an example of how crop revenue insurance might work in 2014 for a 100-acre corn farm with a $4.50 February average for December 2014 corn.

2013 corn crop RP insurance example

  • Corn acres: 100
  • APH yield: 180
  • Chosen policy level: 80%
  • Insured bushels: 144 (A bushels)
  • Uninsured bushels: 36 (B bushels)
  • February average futures price: $4.50*
  • Revenue guarantee (144 bu. × $4.50*): $648

* If the October average for December 2014 corn futures is higher than the February average, then the insured price and revenue guarantee will both go higher as long as you have kept the harvest price election. If the price is lower, you get the February average.

Now, here’s an example of how crop revenue insurance might work using a 100-acre soybean farm with a $11.20 February average for November 2014 soybeans.

2013 soybean crop RP insurance example

  • Soybean acres: 100
  • APH yield: 50
  • Chosen policy level: 80%
  • Insured bushels: 40 (A bushels)
  • Uninsured bushels: 10 (B bushels)
  • February average futures price: $11.20*
  • Revenue guarantee (40 bu. × $11.20*): $448

* If the October average for November 2014 soybean futures is higher than the February average, then the insured price and revenue guarantee will both go higher as long as you have kept the harvest price election. If the price is lower, you get the February average.

4 steps to fine-tune your plan

With the lower prices that you will lock in for 2014, here are four suggestions that I have for this year to help you fine-tune your 2014 risk-management plan.  

  1. Pay up to get a higher level of revenue insurance. If you usually buy 70%, consider going up to 80% or more.

  2. Make sure you keep the harvest price exclusion. A lot can happen by fall to new-crop corn and bean prices.

  3. Use puts on a larger percentage of your new-crop corn and soybeans until futures rally up to an acceptable profit level.

  4. Use all of the marketing tools available. Consider hedges, hedge to arrive, and put options so you have as many alternatives as possible.

NOTE: Trading of futures and options has substantial financial risk of loss and is not for all investors.

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