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New approach to crop marketing

Al Kluis 05/03/2012 @ 1:55pm

In the last four years, I have recommended a three-step risk-management plan that suggests: 1. Buying RP crop insurance. (The right policy is a complex decision that you should work with a qualified crop insurance professional.) 2. Getting the majority of your insured bushels sold ahead. 3. Getting the balance of the bushels covered with put options.

But times have changed, and now my approach will change. I have become more and more disillusioned with results when I use puts.

The real transformation in my thoughts and recommendations came about at my own Lafayette Trading Academy. When the other instructor, Corey Redfield, showed several powerpoint slides comparing hedges to puts, I knew, after looking at those results, I had to change the way I would make recommendations.

These are the two main points that I noticed on the spreadsheets:

● In three of the last four years, having new crop corn and soybeans hedged ahead had been the right financial and marketing decision. In plain English, it made more money.

● In three of the last four years, buying new crop puts has been a waste of money. Only in 2008, when grain prices crashed lower during the great financial meltdown, did put options work. However, in 2008 when puts did work, hedges worked even better.

“Times have changed, and now my approach will change. I have become more and more disillusioned with results when I use puts.”

Penciling it out

I studied many different scenarios and other risk-management alternatives. I worked them back to see how they would have performed in the last 10 years. I used a proprietary rule-based system to make cash and new crop marketing decisions. I then used my research to change the rules. I made some changes by fine-tuning the plan, and I used different percentages of hedges and/or puts.

I found that in eight out of 10 years, having 10% to 20% more corn and soybean crops hedged gave better financial and marketing returns than if 40% to 50% of the crop was hedged and new crop put options were used on the balance.

In the few years that puts do work, you do not make enough extra to cover your losses in the other years.

I then studied the years that puts worked to see if I could determine analogue years that I could use to identify years when puts were more likely to work. I then looked closely to see if I could tell which years puts were more likely to work.

Consider buying the puts because it locks in a price that is higher than your RP crop insurance.

Only buy puts if you can lock in a breakeven that is above the RP crop insurance guarantee. Figure your breakeven on a put option by deducting the premiuim you pay from the strike price you purchase. Buy a $6 December 2012 corn put for 30¢ or less and a $13 November 2012 soybean put for 40¢ or less if futures rally into late June. Otherwise, wait until next year.

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