Advisors are like fitness trainers.
Marketing advisors are like physical fitness trainers. They push you to go outside of your comfort zone. A fitness trainer pushes you for the purpose of improving your physical health. Advisors push you to improve your mental health. Isn’t it true, though, that you don’t always recognize it in the moment?
When your advisor recommends a hedge account to fund your marketing, does it sound like you’ve just been asked to drop and do 50 push-ups? For all but a few producers, the process of writing a check for a margin call or an option premium is painful. Even the process of signing a forward contract can elicit groans.
Ah, but think about what could happen! Fifty push-ups, done consistently, will make you stronger. An investment in options could provide a stronger return on investment. Here’s one scenario, simply to illustrate how hedging can work. Let’s say you pay 15 cents for calls on 165-bushel/acre corn. Your cost-per-acre would be $24.75. If you were to capture just 50 cents of a price move on corn, which has appreciated more than one dollar in the past two months, your return would be $75 per acre. Puts can help you in a similar way, protecting you from downside risk.
The purpose of funding a hedge account is to position you to capture opportunity and manage risk. Your account is cash flow. The amount of funds in an account should depend on production volume and risk tolerance.
A low-risk account might include positions that are fixed risk: put options or forward contracting and call options to protect those contracts. Less money is needed to hedge for these kinds of positions.
At the medium risk level, we’d typically use fixed risk on half of your production and marginable positions on the other half. In the high-risk category, you might want maximum flexibility and be 100% hedged, using futures. No one size fits all. It really depends on the size of your operation and your appetite for risk.
What if you don’t hedge? Let’s look at that realistically as well.
If you’re not hedged, and if the price of corn climbs higher, and if you sell at a higher than average price, you could increase profits and save yourself the cost of hedging. The reality is that most producers don’t sell when prices are rising nicely. They hold out, assuming the price will go even higher, and then miss out. It’s not uncommon to see people ride corn prices down well below a profitable level until they are forced to sell. Among producers responding to a Top Producer magazine survey, the large majority admit to getting caught up in the excitement of a rally and not pricing.
Look at corn right now. It could climb over $5. Should you wait or sell today? How long should you wait? If corn drops, should you sell right away or wait, hoping for a turnaround? If you can answer those questions with a clear understanding of your average price per bushel on your entire crop—and you have the discipline to execute—I applaud you.
If you’re not hedging, the markets are in control of your marketing. You could be considered a high-risk marketer. Moreover, you’re exposed to volatile market moves that cause emotional pain—the very pain from which your advisor is attempting to protect you by recommending a hedge account.
You know what else is great about a hedge account? You don’t have to belong to an exclusive club. You only have to want to take control of your marketing.
Scott Stewart is president and CEO of Stewart-Peterson, a commodity marketing consulting firm based in West Bend, Wis. You may reach Scott at 800-334-9779, email him at firstname.lastname@example.org.
The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Neither the information presented, nor any opinions expressed constitute a solicitation of the purchase or sale of any commodity. Those individuals acting on this information are responsible for their own actions. Commodity trading may not be suitable for all recipients of this report. Futures trading involves risk of loss and should be carefully considered before investing. Past performance may not be indicative of future results.
Any reproduction, republication or other use of the information and thoughts expressed herein, without the express written permission of Stewart-Peterson Inc., is strictly prohibited. Copyright 2010 Stewart-Peterson Inc. All rights reserved.