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Weather market strategy for corn

Agriculture.com Staff 03/24/2006 @ 3:22pm

Corn production the last two years has been outstanding with a record yield in 2004 followed up with another large crop in 2005. Though 2005 had a smaller crop at just over 11 billion bushels, the last two years have seen a massive increase in production. Nonetheless, big supply and cheap prices have kept the demand wheels in motion and growing. The long term picture suggests demand will play an extremely big role providing support for corn prices. An explosion in ethanol, as well as increased livestock numbers, are providing underlying support.

However, in most years, production outstrips demand. This could be different in 2006, as some analysts are suggesting demand could surpass 11 billion bushels or even approach 11.5 billion. We do not disagree. On the other hand, what happens if there is a significantly large crop? You are currently stuck with a delicate balancing act, especially with December corn futures trading in the $2.50 to $2.65 range. You need to make enough sales to make an appreciable difference to your bottom line if prices drop, yet you want to be careful not to sell too much that you limit your ability to participate in a bull market.

Bottom line, farmers have a dilemma. Our bias is to market assuming normal crop production and be prepared in case a weather market develops. One strategy is to consider a ratio CALL spread. What this strategy does is put a farmer significantly long with CALL options. In a weather market, if prices explode, the long CALLS provide outstanding coverage against forward sales. The mechanics of the strategy generally include selling an at-the-money-option and buying three or four out-of-the-money CALL options. There is no set criteria on the quantities.

As an example, sell one December $2.50 CALL for close to 25 cents and purchase four $2.80 CALLS for 15 cents each. The net difference to you is 35 cents. Comparing this cost to an at-the-money CALL at 25 cents, you are spending a dime more plus extra commission. If prices are below $250 at expiration in November, all options expire worthless and you will lose 35 cents plus commission. On the other hand, if prices rally, you will end up with a long position of four $2.80 CALLS and one short $2.50 CALL, or net long three CALLS. The big advantage of this position comes into play if prices rally sharply.

We encourage all farmers to understand the pros and cons of purchasing and selling options. Use options strategically. The ratio CALL spread is an excellent strategy for those who want to go long in the event of a bull market due to weather. It should also provide corn producers the opportunity and confidence to sell cash corn when higher priced sell targets are hit.

If you have questions or comments, please contact Top Farmer at 1-800- TOP-FARM, ext. 129.

Corn production the last two years has been outstanding with a record yield in 2004 followed up with another large crop in 2005. Though 2005 had a smaller crop at just over 11 billion bushels, the last two years have seen a massive increase in production. Nonetheless, big supply and cheap prices have kept the demand wheels in motion and growing. The long term picture suggests demand will play an extremely big role providing support for corn prices. An explosion in ethanol, as well as increased livestock numbers, are providing underlying support.

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