Buy a Call, Make Up for Lost Corn Revenue?
Corn prices have been rangebound, trading near $4.15 December futures for seven consecutive months. Prices continue to consolidate, waiting for news or events to provide direction. On the one hand, there is too much supply and, consequently, the market cannot sustain a rally. On the other hand, prices are relatively cheap compared to the last seven years of pricing opportunities and compared to the cost of production.
One strategy most farmers are not considering at this time is forward contracting and purchasing a call. The math is rather simple. If you forward contract at or below the cost of production and then purchase a call against this, you have now put yourself in a position where you could actually be digging a deeper hole if the call loses money. Yet, most farmers are not interested in just forward contracting either, which implies they are willing to wait for higher prices. In either case, they are not making sales.
We'll take a look as to why farmers should consider forward contracting and buying a call. We're anticipating prices to have some ability to rally as we contend that world supplies will tighten in 2015 and that the final acreage number has yet to be revealed. Unless corn prices rally $.25 or more during April, it is likely an acreage reduction from the March 31 USDA estimate will occur.
It may be beneficial for you to wait for better opportunities. On the other hand, if those opportunities come, it is likely you will sell only a small portion, since the market now has strength. You wouldn't want to sell when a rally is just starting. Here is a strategy to try now. Forward sell from 10 to 25% of your expected crop. Cover these with call options. If purchasing a call, it gives you the right (but not the obligation) to own corn futures. Your risk is fixed to the premium paid, plus commission and fees.
If prices rally, then continue to make additional sales. What you're looking to do is build a strong average. By having the call purchased, you will have confidence to make sales. Often farmers tell us they lack confidence to sell into an uptrend because they are concerned about making a mistake. Early sales appear to be mistakes, and, therefore, they could compound the problem. A call already in place will be a confidence catalyst to stay disciplined and confident to sell.
As an example, if using 0 basis, if you sold December corn at $4.10 and then again at $4.50, this would provide you an average of $4.30. Most likely those who are waiting to sell may only make one sale, even if prices went to $4.50. Whether or not they make additional sales is determined by how friendly they believe the market looks once $4.50 is reached. In 2015, inventory is very adequate. It's likely when rallies do occur, they'll come quick and disappear quicker. Therefore, placing orders above the market to sell more makes strategic sense. A call purchased against the initial sales will provide confidence to sell more.
As with any strategy, you want to be aware of the risk and cost. Marketing decisions are always made without knowledge of future price movement. Yet, by utilizing strategy, you've put yourself in a much better position to manage market moves when they occur, rather than allowing the market to manage you.
If you have questions or comments, or would like help implementing strategy for the year ahead or desire materials that you can read to learn more about marketing, please contact Bryan Doherty at 1-800-TOP-FARM ext. 129.
These strategies may not be for everyone. In any strategy, consider commission costs on transactions, and make sure you understand the ramifications whenever you are in any market position.
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