Hedges or puts: 4 rules for better decisions
A farmer asked two excellent questions at a marketing seminar last winter. I, along with another instructor, researched the answers. Now they have become part of one of the option classes in the Successful Farming(R) Marketing Academy.
The first question: “What works better: Hedging about 50% of my corn crop at the end of June or buying puts on 100% of the new-crop corn?”
The second question: “When is the best time to put on those hedges?”
Before I dive into the details of the farmer’s two questions, I want to explain the overall three-step risk-management plan that I recommend each year.
- Step 1: Purchase the right revenue crop insurance product for your farm.
- Step 2: Get 60% to 100% of the insured bushels hedged ahead.
- Step 3: Get the rest of your production protected with put options.
Second question first
Regarding the second question, knowing the best time to put on those hedges is difficult. I have sold a lot of corn at planting time, and I have always viewed June 20 to June 23 (the Friday closest to June 22 ) as a key time to make sales. This is also a key change-of-trend time period.
Trend change occurs when markets top out and turn lower, or they bottom out and then rally higher. This tends to be a time of extreme highs or lows, but you are never sure which it will be until you get into that time window.
So how do you use this? If prices rally into that window, it is usually a critical time to get the last of the cash corn and soybeans sold and to place some new-crop hedges for both corn and soybeans. If prices collapse, it is a key time to watch for a low to develop and a great time for livestock feeders to buy corn and soybean meal.
In this slideshow, the long- term corn and soybean charts show that corn prices put in major highs in June of 2008, 2009, 2011, and 2013. You can also see the major lows in 2010 and 2012.
For soybeans, the pattern has been similar but not exactly the same. Major highs came in June of 2008, 2009, and 2013. The soybean market put in major lows in June of 2010 and 2012. In 2011, the market put in a short-term low, rallied until August, and then fell into November.
First question second
Regarding the Iowa farmer’s first question of what works better – hedging about 50% of his corn crop at the end of June or buying puts on 100% of the new-crop corn. The charts on the next page indicate that it depends on the year.
By studying the years it worked best and the years it did not work at all, you can develop some basic rules on when to use hedges on 50% of your crop or puts on 100% of your crop. Unfortunately, there isn’t one master plan that works for every farm.
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