The following commentary does not necessarily reflect the views of AgWeb or Farm Journal Media.
This is my fourth and final installment in our series on farmer marketing questions and answers from Farm Journal Economist, Chip Flory. I hope the information provided is of service to you. -Rhonda Brooks
1. This question is from Jessica in New Concord, Ohio: Should I be using my grain bins strictly as a basis improvement tool? If not, what is the best utilization of having on-farm storage?
Chip's answer: No… basis improvement is only part of the advantage of a grain bin. The corn market has made a habit of trading at “full-carry,” or better. That means March or May or July futures trade at enough of a premium to December futures to “pay you” to store the corn until later when end-users want/need the corn in the bin. Capturing that carry can make a grain bin as valuable as the basis improvement. And if basis on summer-month forward contracts is at least average, the carry in the futures market may make it possible for you to lock in a price that’s 25 to 30 cents higher than for harvest-season delivery. And that’s without basis improvement. But, the most-used strategy with a grain bin is speculation… leaving grain in the bin unpriced for a post-harvest, demand-led rally or for a crop scare out of South America.
2. This is a question from Dale in Rockford, Illinois: Should I do a hedge to arrive or basis contract for fall delivery? I am afraid my basis won't improve with a large crop for corn.
Chip's answer: You’ve got your focus on the right factor – basis. If you don’t anticipate basis improvement, then lock-in the basis with either a basis contract (leaving open price risk, but removing basis risk) or a forward contract (zero price risk and zero basis risk).
3. This is a question from Randy in Hoagland, Indiana: What is the difference between a put and a call?
Chip's answer: Give “This is How Options Work” on AgWeb.com a read: https://www.agweb.com/article/this-is-how-options-work-naa-chip-flory/
4. This is a question from Mitchell in Warren, Illinois: Everyone that I talk to and ask for information tells me that marketing is going to be the biggest factor in me making it or not. Being a young farmer and trying to get established, I’m doing my best to be on a strict budget and know my break even. I don’t want to spend extra money on options in marketing and not have it work out, so I feel an HTA is my best option at this time. Any advice would be very much appreciated.
Chip's answer: Not all options (I’m assuming put options) expire worthless… keep that in mind.
But, I understand the “strict budget.” But you’ve got to know your basis. If basis is above the three-year average and you want to lock in a price, either a cash sale or a forward contract is the way to go. If basis is below the three-year average, then use the HTA. All marketing-tool decisions start with basis analysis. If there’s room for basis improvement and the price (futures price) is “acceptable,” use the HTA to leave time for basis improvement. If basis is not likely to improve and price is “acceptable,” cash sale or forward contract.
5. This is a question from Adam in Groton, New York: What drives the basis to fluctuate so much?
Chip's answer: Same factors that cause price fluctuations--Supply & Demand… but demand may have more to do with it than supply. When processors, livestock producers, ethanol facilities – anything that uses the corn after it leaves your hands – are making money, they want to use a bushel and then use another bushel as quickly as they can. That supports basis. If margins for these end-users are low or negative, basis weakness is likely. And that demand isn’t constant. The coverage end-users establish has an impact. If end-users are “hand-to-mouth” on needs, they’re buying as they need it and basis stability can be expected. If end-users have extended their coverage well into the future, that might take a buyer out of the market for a period of time, putting pressure on basis. If an end-user is caught “short-bought” (doesn’t have enough bought to cover short-term needs), that will support basis. (Think of an elevator that has to fill a rail shipment but doesn’t have the corn bought to fill the hoppers). That will often result in a basis push. That’s why it’s important to not only put price-target sales in place, but also make sure your buyers know what basis level will buy the bushels in your bin.
6. This is a question from Tom in St. Anne, Illinois: Why is not selling calls when you are a producer an accepted marketing strategy?
Chip's answer: If you sell a call, the most you can make is the premium at the time you sold the call. If futures prices fall and you keep all of the premium, you are left with the profit from the call premium and exposed to 100% downside price risk. So selling a call will provide “downside price coverage” equal to the premium you receive for selling the call. The problem is, your cash price is also going down so the profit on the short call is offset by the lower cash price. And if prices fall below the strike price, you have the downside price risk on all the cash grain.
If prices rally (pulling the call option premium higher), you’ll be gaining in the cash market, but those price gains will be offset by losses on the short call (and you’ll be paying margin to maintain a short call position). You can do that, just understand that your maximum price is the strike price you sell plus the premium you receive. At that point, it’s basically a hedge. That’s why selling a call should only be done at profitable prices. And even then, there are normally better alternatives than selling a call to protect downside price risk.
7. This is a question from Dale in Rockford, Illinois: Should I do a hedge to arrive or basis contract for fall delivery? I am afraid my basis won't improve with a large crop for corn.
Chip's answer: You’ve got your focus on the right factor – basis. If you don’t anticipate basis improvement, then lock in the basis with either a basis contract (leaving open price risk, but removing basis risk) or a forward contract (zero price risk and zero basis risk).