Being a good marketer means not only knowing your tools and when to use them, but also knowing yourself and how much risk you're comfortable with.
Using futures and options can actually be a more conservative marketing strategy than making cash sales. "Grain in the bin is speculating," says Brian Grete, senior market analyst for Pro Farmer.
"Hedging is more conservative, but that doesn’t mean cash-only can’t be conservative or hedging can’t be aggressive," he said at the Tomorrow’s Top Producer conference in Chicago. "Just keep downside price risk balanced with opportunity risk to match market conditions."
"The first thing you do is define basis," Grete says. That determines not only how you should market but which of more than a dozen market tools in your toolbox is best. "One hundred percent of the risk of true hedging is basis," he states. "Track your basis, comparing it to three, five or 10 years." Your second decision: are you bullish or bearish on the market?
To be an effective marketer, you not only need to understand marketing tools and when to use them, you also need to know yourself and how much price risk you are comfortable with. All tools, whether cash or a variety of futures tools, have their place dependent on market conditions, Grete says. In general, however, hedgers have more flexibility than cash sellers. That’s because they simply have more tools in their marketing tool box, such as futures, both long and short, as well as buying and selling put and call options.
With options, however, consider this: "They capture 70% to 80% of a futures price move," roughly 80¢ for each dollar, not the entire futures price move, Grete notes.
One easy-to-make marketing mistake is euphoria during price run-ups. If corn prices reach $7.50, it’s easy to develop the view that they will go to $8, $9 or even $10, he says. "Last year, corn prices hit $8.43, record prices, but it took the mother of all droughts to do that," Grete says. "At $7.50, demand starts to erode," making sustained price increases beyond that level difficult to achieve.
"I prefer sales of 10%, 15%, 20% as prices rise (incremental selling), but that is really hard to do when things are rockin’ and rollin’," Grete acknowledges. Graduated sales are far easier than putting in stops on the way down, he says.
Both cash-only marketers and hedgers "normally" have 100% price risk on their crops. For cash-only marketers, after forward-pricing 10% of their crop, they are left with 90% downside risk and 10% upside price risk (opportunity risk). Opportunity risk can be minimized with a minimum price contract or a hedge to arrive contract (HTA). A minimum price contract gives opportunity for price appreciation, while an HTA gives opportunity for basis appreciation.
For hedgers, after forward pricing 10% of their crops, they are left with 90% downside risk and 10% upside risk. The opportunity risk can be reduced with a long call option or a buyback in futures. Downside risk can be reduced with cash sales, short futures (hedges) or long put options. Futures and options positions can be adjusted to the appropriate risk level, Grete says.
He suggested various marketing tools for a variety of specific market conditions.
Tools to use with poor basis:
- offensive hedge in the futures market
- defensive hedge in the futures market
- an HTA
- purchase of a put option
- deferred price contract
- doing nothing at all.
Grete adds, however, that there is a cost in doing nothing at all, with the view that basis will increase. Nationally, corn storage costs average about 4¢ per bushel per month, so for doing nothing at all to be most successful, you need a 24¢ improvement in basis over six months. For soybeans, national storage costs are even more, an average of 8¢ per month.
There are four basic market conditions and each requires a different strategy:
- Poor basis/bearish price outlook;
- poor basis/bullish price outlook;
- good basis/bearish price outlook;
- and good basis/bullish price outlook.
For example, tools to consider using with good basis and a bearish bias for futures include cash sales into the spot market, cash forward contracts, and minimum price contracts. Conversely, tools to consider using with good basis and a bullish bias are minimum price contracts; basis contracts; sell cash and buy futures, and sell cash and buy call options.
Grete says you can consider some market tools irrespective of basis: the "courage call" and writing covered call options. A courage call is buying an out-of-the-money call option that gives you the "courage" to make a cash sale when futures reach the strike price. Writing covered call options are selling (writing) a call option that "covers" or helps pay for the cost of a long position in a commodity.
See full coverage of the 2013 Tomorrow’s Top Producer event.
Thank you to the 2013 Tomorrow’s Top Producer sponsors:
Agrotain, Farm Credit, SFP