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Feed buyers shift risk-Bryan Doherty

07/15/2011 @ 4:16pm

For those who buy feed, be on the alert. It's mid July and there is a warm and dry forecast for most of the Midwest. The South continues to broil in hot temperatures as a major drought continues with little or no relief in sight. The vast majority of the corn crop is in good or excellent shape, though there is still one-third that is on the fringe. The weather the next two to four weeks could make the difference between a 163 or 143-bushel yield, or less. If dry weather from the South permeates north, prices could skyrocket. 

As a feed buyer, you want to mitigate the price you're going to pay for corn (or for that matter any feed), and also try to give yourself an opportunity to capture lower prices. We'll look at two methods in order to try to shift the risk. The first will be using paper. The second, and perhaps more important, is the combination of using cash marketing and paper. 

When it comes to using paper tools, you want to look at the possibility of buying futures, buying call options, or buying futures with a long put. All three of the strategies offer upside protection should feed prices move higher. You'll still need to purchase cash feed, so these three strategies do not lock in or manage your basis. What these strategies do is provide a way of shifting risk. The risk or concern with the futures position is that, if prices move down, you will experience margin calls and in essence be shifting dollars between lower cash prices for your commodity and margin call. A call option has a fixed risk component to it and could be a good safety valve in case weather is a factor. Buying futures and buying a put manages the upside against higher prices and also mitigates losses on your futures should the market move down. However, being long futures and long a put does not do away with the margin call requirements the futures position will require. 

A second strategy that livestock producers (buyers of corn) should use is to go ahead and book the corn now. You will be paying a high price compared to history, yet at the same time you'll have ownership, or at least a contract for corn or soybean meal. After booking the cash, then look at buying a put option. If prices falter and weather turns out to be conducive for crop growth, prices could take a significant slide. With hindsight, you'll have paid too much in the cash market, yet the put option provides an opportunity to gain value back in your favor, lessening your overall price for feed. The biggest advantage we see to this strategy is that, in times of uncertainty, you'll have ownership of the commodity, or at a minimum a contract. This puts you in front of all others who may be trying to seek the physical commodity in a bull market when supplies could become scarce and basis skyrockets. 

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