Chip Flory: How to Guarantee a Win-Win

11:06AM Aug 13, 2019
Chip Flory
As Farm Journal Economist and host of the “AgriTalk” radio program, Chip Flory helps farmers understand the markets and seize opportunities.
( Lindsey Benne )

I’m tired of hearing “how different” 2019 is from any other year. But, just because I’m tired of hearing about it doesn’t make it less different. I’ve also asked a lot of questions this year and heard answers I don’t like. But, again, just because I don’t like an answer doesn’t make it wrong.

That’s not easy to accept. And when it applies to marketing, it can be difficult to know how to handle risk management. It’s frustrating. Worse yet, it can make you stubborn when on the “wrong side” of a strategy. For example: Have you been unhedged/unsold, even at profitable levels, when you “know” prices will rise, but they don’t?

A Well-Behaved Market

The markets provided selling opportunities during a rally in the middle of the slowest corn-planting season on record. December 2019 corn futures jumped nearly $1.10 from the May low to the June high before retracing more than half of the rally by early August.

In retrospect, it was a well-behaved market. Prices rallied because there was concern about the impact of late plantings into less-than-ideal conditions. Once that was baked-in prices, the market paused, drifted lower and reset as it awaited the next piece of supply-side information.

Instead of holding steady during the pause, prices sat back because a $1.10 corn rally changed the demand structure. Importers turned to South American corn. And as prices rallied, we learned more about how African swine fever in China and across Southeast Asia threatened corn-for-feed and soybean meal demand. That was a lot to absorb for the corn and soybean markets. Don’t forget the trade war with what used to be the biggest buyer of U.S. soybeans … or the slimmest profit margins for ethanol producers in a decade.

It was easy to see the crop issues and “know” prices were going to improve — and generally ignore developing demand problems. It was, and still is, a market that requires a win-win situation.

Reopen Upside Potential

A minimum price contract is a cash-market strategy that starts with a cash sale (normally a forward contract). The cash sale locks price and basis, but the elevator (for a fee) purchases a call option to reopen upside potential.

The minimum price calculation: Cash price - call option premium - fee = minimum price.

If prices fall, you get the minimum price. If prices rally, appreciation in the value of the call option is added to your price.

Lock in Price

You can avoid the elevator fee and construct the same strategy by making the cash sale and purchasing call options. And if basis is weak, consider a hedge-to-arrive contract (cash contract; locks price; leaves basis open) or a short futures hedge (locks price; leaves basis open) with call options purchased against at least a portion of hedges. Because downside risk in an option purchase is limited to the premium paid, a “minimum price” can be calculated for each of these strategies.

If prices rally, you were sure smart to buy the call. If prices fall, you were sure smart to lock in price.