2022: A year to use put options
The elevated prices farmers are experiencing for crop in the bin and for next year are reflective of many factors. One factor was recognized on the weekly Commitment of Traders report. That is, strong money flow into commodities from the investment community for over a year. The report indicates managed money is net long on almost all commodities. For example, as of the last week of November, funds were net long over 265,000 contracts of corn.
Historically, funds are rarely net long on more than 300,000 contracts. The rationale for being long could come from many areas. In row crops, it is usually reflective of tightening supplies coupled with other variables, such as inflation expectations or large investors diversifying portfolios weighted too heavily with equities. Debt instruments, such as bonds, currently offer little return. It is likely that additional fund money is searching for investments that can offer greater potential than fixed-return investments that pay little, especially during inflationary periods.
When domestic and worldwide supplies are snug, farmers face a dilemma: What will happen if supplies get even smaller? Or the opposite happens, and they grow? History suggests that high prices curb demand and encourage production. The saying is “high prices cure high prices.” Yet, there is no pre-determined timetable. It could occur this year or next, or maybe never.
Worldwide production has been affected by weather disruptions the previous three years. Growing world demand leaves the markets in a difficult position for the year ahead. Continued weather disruptions could suggest that prices are currently pausing before the next leg higher occurs, as the market rations inventory. On the other hand, improved weather and expectations for increased production could suggest much lower prices by late summer. If the price trend turns lower, managed money could quickly abandon their stance on owning and instead heavily sell, reversing their current position to limit losses and take advantage of a downtrend. The initial move downward can be violent, with sharp price declines in a short period of time.
The problem is that there are no easy answers when trying to decide how much and when to sell. While this is a challenge farmers face every year, it could be heightened in the year ahead, with prices currently elevated.
Insurance against lower prices
The coming year may be a year to buy put options and perhaps forward sell less than you normally would. Puts provide you the right (not the obligation) to be short (sell) futures. You can think of puts like insurance against lower prices. Puts establish a price floor. Leave the crop in the bin and expected production unpriced to appreciate in value if prices rally. Have a thorough discussion with your advisor to determine the level of coverage (number of bushels), strike price (level of price floor) and cost. The advantage of puts is that they are flexible (You can enter and exit as you see fit.) and allow price appreciation on unpriced crop. They also can provide peace of mind, knowing you have established a price floor without trying to outguess the market. Think about all the events that have unfolded over the last twelve to eighteen months.
What might the next 10 months look like? Consider puts to take advantage of opportunities when they are offered.
Consider the risks and rewards
As with any strategy, consider the risks and potential rewards before initiating any position. Seek out a trusted advisor to help you, and take control of the uncertainties.
Futures trading is not for everyone. The risk of loss in trading is substantial. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Past performance is not necessarily indicative of future results.
If you have any questions on this perspective, feel free to contact Bryan Doherty, Total Farm Marketing, at 800/334-9779.