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Dairy trading experts offer strategies and practical perspectives to optimize market performance.

How Dairies Can Use Short-Dated New-Crop Options (SDNCO)

Nov 22, 2013

Concerned about rising feed costs in the fall of 2014? Here are examples of these short-term alternatives to trading new-crop corn, soybeans and wheat.

ron mortensen photo 11 05   CopyBy Ron Mortensen, Dairy Gross Margin, LLC

The CME Group started offering short-dated new-crop options in June 2012 for corn, soybeans and wheat. These are short-term alternatives to trading new-crop corn, soybeans and wheat. Simply stated, they are options that expire earlier than traditional options.

Traditional options for December corn would expire in late November. The short-dated options now are available for March, May, July and September. So, the options will expire in the last part of February, April, June and August. Traditional options for November soybeans expire in October. Just like corn, the short-dated options in soybeans can be traded in March, May, July and September. Expiration is also sometime in the end of the previous month.

How would a dairy producer use SDNCO options?

Feed
If you are concerned about rising feed costs for the fall of 2014 and early 2015, you could buy a SDNCO July or September call option. If there is a weather market in the summer, you may be able to capture some the gains. The profits from the option could be used to lower your feed costs in the last quarter of 2014 and first quarter of 2015. Remember, the July SDNCO option will expire in late June, and the September SDNCO option will expire in late August.

This is an example of a way to protect the cost of silage that you purchase. Buy a September SDNCO $4.60 call that expires in late August for about $.35/bu. If corn is above $4.60, you will have value in the option to pay for the higher-cost silage. If December corn is below $4.60, the option will be worthless, but you will be able to buy the silage cheaper.

Some farming operations and dairy operations try to do business as separate profit centers. SDNCO’s are a simple way to market your corn and then transfer the corn to the dairy operation in the fall.

If you buy a July SDNCO or a September SDNCO put, you will be putting in a floor price for the corn you grow. The September $4.50 SDNCO put can be purchased for $.34/bu. If December corn is below $4.50, you will have value in the option. At that point, you can sell the corn or silage to the dairy operation. If corn prices are above $4.50, you will sell the corn to the dairy operation at the higher price.

SDNCOs could be used to hedge the value of the crop insurance price that is established in February.You would simply buy a SDNCO March corn put that expires in late February. If prices move lower, you can use the gains from the option trade to enhance your February crop insurance price. If prices move higher, the option will be worthless but the February crop insurance price will also be higher.

Corn Comment

In the November report, the USDA reduced Chinese feed grains (corn) use for industrial purposes—basically starch and ethanol. This increased stocks by about 500 million bushels in the world. USDA did not increase Chinese feed use. Industrial production decreases could be because of a slower economy or government pressure to make sure adequate feed supplies are available.

For the U.S., the USDA did increase increased corn feed/residual use and exports.

The November estimated corn yield was 160.4 bu. per acre. The record yield was 164.7 bu. per acre in 2009. This report did show record total production at 13.989 billion bushels vs. the last record of 13.1 billion bushels in 2009. The large crop size came in spite of a reduction of 1.9 million planted acres from the last report. Record corn yields were reported in Illinois, Indiana, Ohio, Michigan, Pennsylvania, Kentucky, Tennessee, North Carolina, South Carolina, Virginia, Georgia, Alabama, Mississippi, Louisiana and Arkansas.

In December, the USDA will release a supply/demand report, but it typically has little impact. On Jan. 10, 2014, the USDA will release stocks, final crop size and the supply and demand balance sheets. With so much data, the January report has proven to be a market mover in the past.

Ron Mortensen is principal of Dairy Gross Margin, LLC, an agency that specializes in LGM-Dairy products, and owner of Advantage Agricultural Strategies, Ltd., a commodity trading advisor. Reach him at ron@dairygrossmargin.com or visit www.dairygrossmargin.com.

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