Power Hour: Wheat Marketing? Think Options

April 26, 2013 09:30 AM
 
Wheat Dollars

With the winter wheat crop highly uncertain as it first had to face drought during fall planting and now repeated freezes, it might be tempting to think you have to wait before doing any marketing. True, growers are not well advised to lock in prices with forward contracts, since they don’t know yet whether they’ll get much of a crop, says Dan O’Brien, ag economist at Kansas State University (KSU).

There’s another marketing path, however, and that’s put options, O’Brien adds. "Options are a good possibility," he says. "They’re pretty affordable." First, however, look at your crop insurance coverage and develop a marketing plan in relation to that, O’Brien suggests.

On April 25, a July in-the-money put option for July hard red winter wheat at $7.60 on the Kansas City Board of Trade was running 31 cents. On the same day, wheat futures jumped over 20 cents on concerns by traders about the crop. Puts allow producers to take advantage of these up moves in the market. O’Brien notes that in times past, options have carried premiums as high as 50 to 60 cents; so by comparison, the premium on today’s options seems like a bargain.

Minus the premium, put options allow growers to establish a price floor of $7.25. For a western Kansas grower with trend yields of 45 bu./acre, all costs come to $6.95/bu., according to KSU farm management budgets. So today, a grower with average yields in 2013 can lock in a 30 cent profit. However, it’s a different story for growers with only 35 bushel yields.

For these growers, break-even is $7.64, so with a $7.25 floor they are not covering all costs, O’Brien notes. Still, they might want to consider puts to avoid larger losses later by doing no marketing, he adds, but this is a highly individual decision.

No question, the wheat crop in the plains has been hurt, but no one really knows yet by how much, O’Brien says. Moreover, while recent rains have recharged the topsoil, subsoil moisture is still lacking. "The crop is definitely slow. There have been cold temperatures and freeze issues." It’s still possible for close to normal production, however, if growing conditions now through July are ideal, O’Brien says. Absent that, yields will be hurt.

O’Brien gives a 30% probability to low production that would result in stocks-to-use of 21%. If this occurs, he predicts that prices could jump to $8.50 to $9/bu., about $1 higher than present futures prices. Even worse yields could create the unlikely though possible prices of $9.50, in which minimum historic harvested-to-planted acreage levels of 76% occur.

He gives 65% odds of trendline yields, with accompanying prices of $7.50. He only gives 5% odds for above trendline yields, which would lower prices to an estimated $7.25/bu.

Growers need to think about more than just wheat, however. "In the broader picture, outside or non-wheat influences are impacting wheat prices. The most likely causal factor is cross market/arbitrage impacts from historically tight U.S. and world feedgrain prices and associated record high feedgrain market prices, "O’Brien adds.

Given the uncertainties regarding 2013 wheat production prospects in the U.S. and also for other major world wheat exporters such as Australia, Argentina and the Black Sea region countries, U.S. wheat prices are likely to remain high through at least early spring months, he says.

Moreover, it’s not just hard red winter wheat in the central plains that’s in trouble. Concern about wet soils and delayed planting of spring wheat is growing, but not at a fever pitch at this time, O’Brien says. "However, should these wet conditions in the Northern Plains persist into mid-May, then 2013 U.S. Northern Plains wheat acreage and yield prospects will become a serious market factor."


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