Manage risk with crop insurance and marketing tools
One of the most challenging responsibilities of a farmer is to manage risks—and deciding how much money to spend to control those risks. That’s where crop insurance comes in. It allows producers to reduce downside risk without forfeiting upside potential.
To show how marketing and crop insurance go hand-in-hand, let’s take a look at three marketing scenarios for a hypothetical central Indiana farm. With gross costs of $760 per acre and an estimated corn yield of 160 bu., basic costs total $4.75 per bushel.
Scenario No. 1. If a farmer decides to forgo crop insurance, takes on all the risk himself and sells early December corn futures at $5.62 (as of late March), the market offers a $100 per acre contribution to land, management and overhead.
If prices drop below recent market values, profits quickly follow suit. The only way for profits to improve is if individual yields increase at the same time prices rally. This is what happened in 2012 for northern Midwest corn producers who weren’t suffering from the drought.
In summary, 160 bu. yields and low prices could be financially painful unless your costs are significantly lower than the suggested $4.75 per bushel basic costs plus the 25¢ basis.
Scenario No. 2. Assuming the same basic costs as the first scenario but adding 85% revenue protection at $19 per acre caps maximum downside risk at $58 per acre while leaving upside potential in place.
Scenario No. 3. Based on an 85% revenue protection coverage level, let’s diagram how crop insurance and adjusting option positions based on market conditions can maximize returns.
This strategy involves placing long puts first in the September futures, then rolling to the December futures at $5.62. The current 30¢ premium makes the current net return higher than expected. This strategy reflects buying deep-in-the-money September $7.20 puts for $1.35 to create an artificial futures position, but with a cap on cash flow exposure that does not exist with a net short futures position. Note: The worst day for cash flow is the day it is implemented (not in June and July if we get a full-blown weather event).
At the same time, buy deep-out-of-the-money December $7 calls for 12¢ to provide upside price protection for the expensive put premium, which will be liquidated as soon as the risk of yield loss seems to have passed.
The downside of this strategy is the eventual time value decay cost of 10¢ for the puts plus 12¢ for the long calls, which will not be reflected until later in the year.
The table at left indicates this strategy is more profitable at the 160 bu. per acre yield level regardless of whether prices go up or down ($98 per acre). If yield increases relative to price, the bottom line improves. The risk is a farmer’s yield falling relative to price. In the coming months, he must try to recover the time value paid in the September puts (for example, roll up the puts if the market rallies), and finally liquidate the long calls once the risk of yield decline is over. Granted, he has more decisions to make than the farmer using the "do nothing" strategy, but the decisions are much easier to manage than the guessing game.
In addition to the direct marketing decisions, there are several other factors that will influence profitably:
- How long should I store corn? When should I roll short positions to take advantage of spread changes?
- When do I lock up basis bids against cash sales?
- Do I need to have long call protection into the fall months if spring planting is delayed and there’s an increased likelihood of an early frost later this year?
- What do I need to do to reduce the net cost of crop insurance premiums if the market would rally or if it significantly breaks between now and early September?
- How aggressive should I look at selling my 2014 crop if we assume there will be 96 million corn acres and a 155 bu. average yield for the next two calendar years?
To see how crop insurance and marketing tools can work together as the market fluctuates, visit www.FarmJournal.com/crop_insurance
This material has been prepared by a sales or trading employee or agent of Utterback Marketing
Services, Inc., and is, or is in the nature of a solicitation. This material is not a research report prepared by Utterback Marketing Services, Inc. By accepting this communication, you agree that you are an experienced user of the futures markets, capable of making independent trading decisions, and agree that you are not, and will not, rely solely on this communication in making trading decisions. Distribution in some jurisdictions might be prohibited or restricted by law. Persons in possession of this communication indirectly should inform themselves about and observe any such prohibition or restrictions. To the extent that you have received this communication indirectly and solicitations are prohibited in your jurisdiction without registration, the market commentary in this communication should not be considered a solicitation. The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results. Trading advice is based on information taken from trades and statistical services and other sources that Utterback Marketing Services, Inc., believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades.