When creating a risk management plan, emphasize crop insurance as one of the numerous profit centers in
your operation—even if that means using unconventional insurance methods.
In the next month or so, depending on how soon you’ll start harvest, walk through your fields to get a handle on yield potential. Take that expected yield and multiply it by the futures price for corn and soybeans on the same day to determine an early harvest revenue total. If the estimated harvest revenue is less than the insurance revenue guarantee, the insurance policy is considered to be in the money, meaning at that point and time, there would be an indemnity payment.
Unfortunately, there is still time for futures prices to fluctuate. An overall increase in prices in October might be good for your marketing sales profit center, but it has an adverse effect on the insurance profit center
because the indemnity starts to go away. As a result, managing upside price risk should be part of your overall risk management plan.
One way to take advantage of an increase in prices is buying calls—if prices increase, then the profits made with the calls will help offset the shrinking indemnity payment. The downside to buying calls in this scenario is prices have to rally enough to first cover the cost of the calls. If the market doesn’t perform as projected, the calls became another burden.
The preferred method to hedge against rising prices is to sell puts in early October. If prices go higher, the money collected from selling puts will help offset the loss of an indemnity payment. If prices fall after selling puts, then the money received from selling them will disappear, but the indemnity should get bigger. This is called a covered insurance hedge because a strategy has been put in place to recoup or even make money regardless of market fluctuations. Coupled with this strategy, if the average harvest price moves high enough to exceed the spring price, which increases the revenue guarantee, a farmer with yields below his or her APH (actual protection history) can greatly benefit to help compensate for the losses in his or her fields.
When trying to determine an average monthly price, big movements generally occur in the first half of the month. The daily futures price movements in the second half of the month aren’t going to have as much effect on the overall average. If the hedge is performing well enough, go ahead and take profits near the middle of the month without much concern of leaving a lot of money on the table. If prices get wildly bullish, consider adding back the hedge.
When using options, keep in mind they generally don’t cover bushels on a one-to-one basis. They have what are called deltas that determine what percent of a bushel they really cover. Talk to your broker to ensure you use the right amount of options.
Just a reminder: When an insurance policy is in the money because of the price component, it acts like a put on the covered bushels. This can be a good time to lay off some of the price risk by lifting any short futures, sold calls or puts. If prices rally, lifting the hedges saves some money, and if the price moves above the insurance put price, consider adding some downside protection.
Don’t forget, because of the deductible, there are always bushels not covered by insurance. Those bushels are exposed to downside price risk. Once the insurance period is over, all remaining bushels on farm are fair game for downside price risk.
As a market analyst for the Gulke Group and owner of Wasemiller Insurance, Jamie Wasemiller helps farmers pair crop insurance with risk management.