Risk Management with Insurance Tools
Insurance tools have become an integral part of managing your farming operation. Stay current on insurance tools and how to incorporate them with your current risk management strategies to market your grains throughout the year.
Protecting Your Current Insurance Indemnity Payment
Sep 12, 2013
If you have an APH of 200 and buy 80% coverage you have a trigger yield of 160 bu. Take that times $5.65 and your insurance guarantee is $904 per acre. Currently the price is at $4.70. Take that price times your currently projected expected yield to determine how much you are currently above or below your revenue guarantee as of today. This is a very important number to know. Here is why.
If you are in an area that has been hit hard and have a potential yield of 140 bu with the current price of $4.70 the harvest revenue would be $658. If that is the case than the insurance indemnity would be $904-$658 or $246 per acre.
In this scenario you are 30% below your APH which means the corn price has to go a lot higher before you DON’T get an indemnity payment. Currently this farmer has a big indemnity already locked in and they would have NO REASON to have short futures or sell corn as insurance now is acting like a put option. Also, as prices go higher your insurance indemnity decreases. Even if the price goes higher than the spring price you will not bring in as much money as if the price stays at their current levels.
So, with poor yields at this price you have UPSIDE PRICE RISK to consider—so buying calls ahead of the report just in case we’re blind-sided by a bullish report, would be a prudent thing to do. What to buy? Consider the ATM Oct calls that are currently around 11 cents or the Nov ATM which are about 19 cents. The Oct’s calls are cheaper and will get you through the Sept report and its aftermath but they do expire in just over a week. The Nov calls are more expensive but will get you through the Oct report and this critical next month for the markets. Take your pick. Also, if the report is not bullish you can sell that call you purchased and probably get back about half of the premium you paid so the risk is not that great. Another option would be to buy a call spread to mitigate the price even a little more but there is not that much money to gain from selling a higher priced call so it may not be worth it but if cost is a concern this is another option.
If you are in an area that has had good weather and has a potential yield of 220bu at $4.70 the harvest revenue would be $1034 versus the original revenue guarantee of $904. If that is the case than the corn price would have to get below $4.11 before insurance would kick in.
So, with good yields at this price there is still DOWNSIDE PRICE RISK so consider buying either the Oct or Nov ATM puts which are about the same price as the calls mentioned above.
Another way to look at it is to take the original guarantee of $904 and divide that by the current price of $4.70 which would determine the yield reduction you would need to be at before your insurance would kick in. In the case above $904/$4.70 is 192 bu. Because of the current price compared to the Spring Price it only takes a 4% bu loss before an indemnity is triggered. This helps to show the value of utilizing the Revenue Protection insurance plan.
Farmers will sometimes get locked in looking at gross revenue per acre which is made up for cash sales, harvest revenue (taking the harvest price of corn times the remaining bushels not forward sold) and the insurance indemnity. Each piece of the equation should and can be effectively managed. In the scenario above if you left your bushels constant as prices fluctuate anywhere below the spring price the gross revenue will stay the same until you go higher than the spring price of $5.65 in which case the gross revenue will start to increase. In our case of price being at $4.70 and potentially going higher the gross revenue stays the same because as price goes up the insurance indemnity goes down but the harvest revenue part of the equation goes up. If you can use some simple low risk market strategies such as the one mentioned above to capture some of the indemnity that would normally go away as prices go higher you have now increased the revenue of the insurance piece which should help increase your overall gross revenue per acre.
If you have any questions or would like to know more about how to incorporate insurance and grain marketing, feel free to contact me at Jamie@gulkegroup.com or at 707-365-0601. You can also contact me if you want me to send a graph that shows you visually how the insurance indemnity changes based on the movement of the futures price in the example above.
There are substantial risks involved with both futures and options trading. While risk is limited to purchase price when buying an option, it is not limited when selling an option. Commodity trading and other speculative/ hedging investment practices involve substantial risk of loss. Past results are not necessarily indicative of future results when utilizing the commodities markets. This material and any views expressed herein are provided for informational purposes only and should not be construed in any way as an endorsement or inducement to invest.