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Hedging Time is Very Near.

Published on: 12:29PM Aug 01, 2010

 In addition to the Russian and Chinese weather problems (a bit of a mess, for the Russians to actually have their wheat fields on fire) is the dollar retreat.

The dollar is likely to go down against all major currencies except the Yuan (China) which is controlled by the Chinese government. Major targets are likely to be reached about two weeks out. That adds risk to the long side of grains and beans.

The point I wish to make across yesterday's post and today's is that we are rapidly approaching the time when going unhedged will have risks that considerably outweigh profit potential.

Choices of instruments: futures contracts and options.
Actions: 1. Sell contracts for delivery.
               2. Sell calls.
               3. Buy puts.
               4. Combinations.

The one choice that makes no sense to me is to buy puts. I just don't see a favorable cost /  benefit ratio there.

Selling contracts for delivery, probably in about two weeks, is the simple, straight forward approach. The risk is in selling more than your harvest will produce, once all is said and done on one hand, or selling significantly less than production on the other.

Selling calls puts money in your pocket now, but if the premiums you collect turn out to be less than the price decline (if there is a decline) that happens before you get your crop sold, you don't do as well as selling contracts for delivery. If prices rise into delivery, you do better than selling contracts because while you still get to make delivery, you have the premiums collected as well as the strike price you selected.

Mixing selling calls with selling contracts: that is a strategy which seems like the best approach. Plan to sell most of your "absolutely certain" production with contracts, then sell calls for the remainder of your "certain" production plus your "likely" and perhaps even your "maybe" production.

If you have questions about ratios and expirations, contact me.