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Smart Cash, Smart Re-Ownership Strategies
Crops are engulfed in price volatility and adverse weather. You might feel overwhelmed trying to determine how much crop to commit for delivery in a forward sale. Sell too soon, and you give up the opportunity to gain if prices continue to rally. This needs to be weighed against doing nothing, and feeling the pain of losing dollars if prices drop. The key is a balanced approach. You can manage through the volatility, your emotions, and cash flow with this balanced approach: Make smart sales (cash sales that work for the farm operation) and retain ownership with fixed-risk call options.
When prices rally at this time of year, it is usually on some type of weather event. These rallies often do not last because weather and the forecasts change. Consequently, prices erode, and usually very fast. Sales not made loom large when year-end revenue is calculated. So far, this year’s weather is a concern, and the market has rallied. When do you hold off on making sales, and when do you sell regardless of where prices are headed?
For most producers, a comfort zone is to sell 25% to 50% of expected production by June 1. This will likely be the case for many this year. For those who are short on acreage, however, or have planted late, 25% to 50% of expected production could be a much larger number, and has them outside their comfort zone. Therefore, creating a balanced approach is even more critical. The key is to be active in pursuing an approach that allows you to forward sell at a comfortable level and cover sales with call options. Purchasing a call option gives you the right (not the requirement) of ownership of futures. If prices rally, your forward sale will fall behind, and your call option can gain value.
Let’s look at a very simplistic example. If you forward contract corn based off December futures at $4.35 and purchased a $4.50 call option for 27¢, you’ve accomplished two tasks. First, you have put a price floor based off December futures at $4.35. Second, if futures are above $4.77, you will then have a one-to-one re-ownership. One-to-one means that for every penny futures go up, your call option will be worth a penny at expiration. If corn futures were to rally to $6.00 and re-owned at $4.70, your net price is $5.65 based off December (not reflecting basis and commission or fees). If, on the other hand, futures were to drop to $3.50, you have an average board price of $4.35 (less the costs of your option) or a December futures price equivalent to better than $4.00. In either example, you know your end price based off strategy, regardless of where the market goes.
Smart cash sales with smart re-ownership strategies prepare you for any market action and will keep you in your comfort zone.
If you have comments or questions, contact Top Farmer at 800-TOP-FARMER, extension 129.
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.