Is A Loss In My Hedge Account A Good Thing?
Nov 20, 2017
Market Commentary for 11/17/17
As harvest finishes with record yields across the Midwest, corn prices fell below $3.40 this week (for the week nearly unchanged though). Many farmers have struggled to sell at profitable levels, and while higher than average yields help offset lower prices some, it hasn't been enough. Also contributing to lower prices, funds continue to hold large short positions with little incentive to adjust.
Beans also had average or above average yields throughout the Midwest, but unlike corn prices beans have been high all year long in relation to corn prices, which has allowed for profitable levels for most farmers. This has eased the sting of low corn prices for many farmers. Looking forward, South American weather forecasts have been favorable, but soon every forecast adjustment could drastically change market direction.
Basis values are increasing throughout the Midwest for both corn and beans. This means farmers aren't selling and end users are looking for some coverage. Also spreads between futures contract months have narrowed slightly, which sometimes can mean we've hit a bottom.
2018 may be a unique marketing year as farmers sell beans earlier and corn later, waiting for a rally. Some in the trade may be surprised how long farmers will hold out on the corn, in an effort to get higher prices. While I'm not overly bullish corn, I think a 10-20 cent increase in the short-term could be reasonable.
Should My Hedge Account Show A Profit Or Loss At The End Of The Year?
Farmers are often disappointed if their hedge account doesn't show a profit at the end of the year. Others assume that they will always lose money in their hedge account. I tell farmers that profits or losses at the end of the CALENDAR year don't matter. What I find to be the most import thing is if my grain's FINAL CASH VALUE HEDGE GAIN or LOSS is above profitable levels.
A farmer sells corn for $4.00 futures and a zero basis level
Raises 100,000 bushels
Loss in hedge account = - $20,000
Net value of corn: $3.80
(Math: -$20,000 / 100,000 bu. = -.20 $4.00 = $3.80 net cash value)
Farmer sells corn for $3.80 futures and a zero basis level
Raises 100,000 bushels
Profit in hedge account = $10,000
Net value of corn: $3.90
(Math: $10,000 / 100,000 = .10 $3.80 = $3.90 net cash value)
Farmer sells corn for $3.60 futures and a zero basis level
Raises 100,000 bushels
Profit in hedge account = $40,000
Net value of corn: $4.00
(Math: $40,000 / 100,000 = .40 $3.60 = $4.00 net cash value)
When farmers don't combine their cash grain price with their hedge account's profit or loss they don't fully understand their farm operation's actual profit or loss. It doesn’t always mean that low prices on the check from the elevator are bad. Actually a low cash value with big hedge profit can turn out to be the best thing.
That's why I ALWAYS understand all possible outcomes of each trade when I place them. I want to know what my potential net position (i.e. my real profit price) is in advance. If I make money in my hedge account, but don't sell any grain, I have no guarantee that I’m going to be profitable. If I lose money in my hedge and sell grain at unprofitable prices, then I could be in an even worse situation than doing nothing.
Only by understanding all possible scenarios for each trade and how that will affect my final cash value can I really market my grain effectively and efficiently for my farm operation. A true hedger doesn’t care if they make money in their hedge account or on the cash sale of the grain. A true hedger only cares what their net priced received for all of their grain was for the year including the profit or loss from their hedge account.
Market Action - Sold Another Straddle
Again, I expect a sideways market for the next 2 months. Since prices are unprofitable, I want to "manufacture" some premium in the market while still maintaining low overall risk. Therefore, on 11/16/17 when March corn was $3.49, I made the following trade on 10% of my ’17 production
- Sold – February $3.55 straddle, where I sell both the $3.55 put and $3.55 call and collect just over a 17 cent premium
- Trade Expiration - 1/26/18
- Potential Benefit - If March futures close at $3.55 on 1/26/18, I keep all of the 17 cent premium
- Potential Concern - Reduced or no premium if the market moves significantly in either direction
- Every penny lower than $3.55 I get less premium until $3.38
- $3.38 or lower and I will be losing money on this trade penny for penny
- Every penny higher than $3.55 I get less premium until $3.72
- $3.72 or higher - I have to make a corn sale at $3.55 against March futures, but I still get to keep the 17 cents so it’s like selling $3.72
The biggest risk in this trade is if corn is below $3.38 at the end of January because I'll lose money on this trade. If this happens, I can buy the straddle back and take a loss, or remove a previous sale I have made, and take any profits on the difference between what I sold in the past on another trade and $3.38, against the March futures. Then I can wait for a future rally and sell again, adding that premium to another sale. While I hope this doesn't happen, and I think there is a low chance it will, I still ALWAYS understand the worst case scenario for all of my trades and I am willing to accept them. It is also why I limited the amount of bushels I placed in this trade to 10% of my ’17 production.
Superior Feed Ingredients, LLC
9358 Oak Ave
Waconia, MN 55387
This email material is for the sole use of the intended recipient, and cannot be reproduced, disseminated, distributed or electronically transmitted, including any attachments, without the prior written permission of Superior Feed Ingredients, LLC.. Even though the information contained herein is believed to be reliable, we cannot guarantee its accuracy or completeness, and the views and opinions expressed are subject to change without notice. Trading commodities involves risk and one should fully understand those risks before buying or selling futures or options. This data is provided for information purposes only and is not intended to be used for specific trading strategies.