Time to Reown Crop Production, Analyst Says
Harvest is progressing and farmers are turning their attention to managing their production (inventory).
Many will be faced with decisions on whether to store, sell, or sell and reown. Each has its own merits. For this Perspective, we will look at the retained ownership position. We will take a look at three strategies: one with unlimited risk/return, one with fixed risk and unlimited return, and one with fixed risk and fixed return.
The most straightforward reownership method is to purchase futures contracts.
Which contracts? Some believe it’s best to purchase the nearby month and roll to deferred months as the contract expires.
The goal is to avoid buying the carry in the market. (Carry is calculated as the cost of holding corn/soybeans in storage.) Currently, December corn futures are trading less than March, which is trading less than May, which is trading less than July. As an example: December corn is trading at $3.69 and July at $3.94. The differential is the carry – in this case, 25¢.
Others believe it’s best to buy July futures and avoid the rollover charges of exiting one contract and entering a new one. The idea behind buying the front month futures is that you are continually buying the lower price. Yet, when moving out of the front month, you will still be buying the carry in the next month.
Knowing that, our bias is to buy July, as this represents the last remaining old contract (2018 crop) trading for corn. If you are retaining ownership for soybeans, August is the last old-crop contract available. By purchasing the more deferred contracts, you avoid roll charges and have a much longer time horizon to be in the market.
Futures contracts have an initial and maintenance margin requirement. This is considered a good faith down payment that needs to be maintained on a timely basis. This means that if your futures positions lose value, you will need funds readily available to maintain the position. Futures contracts move daily, so you may experience gains or losses daily, similar to your crop in the bin gaining and losing value as the market moves.
A second ownership method is to buy a call option. A call option can be purchased through a licensed adviser, or in some cases, through elevators. The owner of a call option has the right to own futures, but not the obligation.
Calls are sometimes viewed as upward price insurance protection. You have a fixed risk (the premium) and unlimited potential. These are often advantageous for those who want quantified risk and unlimited potential in a price rally. The disadvantage is that time erodes the option’s value if prices do not rally. In addition, if you are buying deferred months, you are buying call options that represent carry in the market.
A third way to retain ownership is to purchase a bull call spread. Here, you purchase a low strike price call and, at the same time, sell a higher strike price call. The premium for the sold call directly offsets the cost of the long call. In other words, your out-of-pocket expense is less than if you were to buy just the low strike price call.
The disadvantages to bull call spreads is they are typically slow moving (as futures move higher) and they have a fixed profit potential. The advantages, however, are that risk is fixed and that, in an upward market, they can provide a return. These are often used when volatility is high, or when you want ownership for an extended period of time, as you are buying and selling time value.
In the end, find a strategy or combination of strategies that works best for you. Your goals, risk tolerances, and abilities may be different than your neighbor’s, so use the tools that best suit you. Often we are asked what the best strategy is. Only hindsight will tell you with clarity what should have been executed. One suggestion, however, is to not gamble by trying to time the market. Make it seamless. On the day you sell, retain ownership.
If you have questions or comments, contact Top Farmer at 1-800-TOP-FARM, ext 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.
Carol Tillmann Operations Support | Stewart-Peterson Office: 800.334.9779 | Fax: 262.334.6225 email@example.com
Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Hypothetical performance results have many inherent limitations. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. No representation is being made that scenario planning, strategy or discipline will guarantee success or profits. The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Reproduction of this information without prior written permission is prohibited. This material has been prepared by a sales or trading employee or agent of Stewart-Peterson and is, or is in the nature of, a solicitation. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Stewart-Peterson. Stewart-Peterson refers to Stewart-Peterson Group Inc. and Stewart-Peterson Inc. Stewart-Peterson Group Inc. is registered with the Commodity Futures Trading Commission (CFTC) as an introducing broker and is a member of National Futures Association. Stewart-Peterson Inc. is a publishing company. A customer may have relationships with both companies. Accordingly this email is sent on behalf of the company or companies providing the services discussed in the email.