Market Commentary for 5/11/18
The first look at the '18/'19 USDA supply and demand estimates were published this week.
Corn yields are predicted to be 174. If this happens, US carryout would reduce from the current 2.1 billion to 1.6 billion next year, a 20% decrease. World carryout predictions were also reduced by nearly 20% as well. Both seem to be a long term potential positive for the corn market.
Unfortunately the market didn't react well to the bullish news. Some in the trade were suggesting that large carryout in US and world wheat stocks were just too bearish and that those projections pulled corn down. Still, a weather scare over the next 60 days could shift the course for corn prices, because there is little weather premium in the market. However, if national yields approach 177 , a rally will be unlikely and prices could eventually fall well below $4 for Dec corn futures.
Beans also had a little bullish news, as world carryout dropped 6% and US carryout is predicted to decrease 20%. Still, tariff and export pacing uncertainty continues. As in corn, weather issues will be the biggest factor over the next 90 days.
I'm frequently asked how the gains and losses are reflected in my hedge account when I detail out my trades. Hedge accounts can be overwhelming to farmers when they first use them. I was confused the first time I saw how it was done. At first it can be unclear how all the different types of transactions will show up in a hedge account and how profits and losses will be displayed. For example, some farmers may not realize that they need to account for the cash price of the check they receive from the end user.
That's why I don't use my hedge account line items and summaries to determine the value of my corn. Instead, I prefer using spreadsheets where I track all of my trade detail to determine my final prices for the corn I sell. Doing it this way allows me to better understand how market carry, basis, futures and options affected my overall price position.
The following illustrates my point. Below I show a summary of my current corn position broken out by futures, carry, basis and options. I then detail out how it would have shown up in my hedge account. Then I show the math of how one can use the hedge account summary to still get to a final cash price.
Walking Through The Trades
I always start with my original sold futures price, the spread or market carry I collected, any premiums received from options trades and the basis value I sold to determine my final cash price.
Following is my current 2017 corn positions (52% sold futures position) that I shared last week:
- $3.57 – Futures
- $0.05 – Average Market Carry From Dec to May futures
- $0.09 – Market Carry premium from May to July futures
- $0.64 – Options Premium
- $4.35 – Equivalent value against July Futures
- -$.42 – Basis verses the July futures picked up on the farm
- $3.93 - Final Cash Price picked up on the farm
Basis History - I set my basis on 50% of my ’17 crop back in March to be picked up on my farm in June/July for -.42. When I set the basis with an end user I give them cash grain in June/July and they give me futures, July in this case, so both of our positions remain equal in our respective accounts.
Side Note: This is a very common transaction and how most big grain companies sell grain to one another. Instead of exchanging futures with an end user, I could have just bought my futures position back in the July contract. However, doing it this way assures that I won’t have any price risk between when I call the end user to price the grain and when I call my broker to buy the futures back. Either way of doing the trade will cost me the same amount in commissions.
Dates And Summaries Of The Above Trades in my Hedge Account
3/5/18 - I set my basis on 50% of my '17 crop to be picked up on my farm in June/July for -42 cents. As stated above, when I exchanged futures with the end user, they gave me July futures at $3.93 (the July futures value on 3/5) because I was giving them cash grain. This means the end user will write me a check for $3.51 ($3.93 (-.42) cents basis) after the grain has been picked up off my farm. My hedge account after the exchange showed that I was long July futures at $3.93.
4/20/18 - Some of my options got exercised. I also had some sales already on from previous trades that were already short May futures at $3.57 futures 5 cents of Market Carry from previous futures months that were eventually rolled to May futures. My account will show that I'm short May futures for $3.62.*
*The actual value in my account might have been a different value to get to that point, but I would have incurred a profit or loss in past trades up to this point that would have made the value of corn in my account this level.
4/24/18 - I rolled my May position to July and collected 9 cents of market carry profit. That was done by buying the May futures back at $3.79 and selling July at $3.88. That transaction means that I’m buying my short May futures back and selling July futures. Because I was long July futures from the basis trade those contracts are offset and disappear from my hedge account as well as the May futures.
How My Hedge Account Looked After Each Trade
3/5 -Exchanged futures with end user -causes long July futures at $3.93
4/20 -Options were exercised against the May -caused short May futures at $3.62
4/24 -Bought back May futures to collect carry -caused long May futures at $3.79
4/24 -Sold July futures to collect market carry -caused short July futures at $3.88
Hedge Accounts Aren't Always Nice And Neat
After the 4/24 market carry trades, both my May and July positions disappeared from my account and it looked like the following losses happened:
- May futures that had been sold for $3.62 were bought back for $3.79 = 17 cent loss
- July futures which were given to me when I set my basis for $3.93 were sold for $3.88 = 5 cent loss
Those two trades combined are a 22 cent loss that must be subtracted from my final cash price I'll get from the end user in July. That means the value of my grain is worth $3.29 ($3.51cash price – .22 hedge loss). However, as I mention above in my positions, I still have 64 cents of options premium that I've collected in my hedge account along the way. I now need to add that value to the $3.29 price and it makes my true cash value for my grain $3.93.
As you can see, by doing the long version of the math in the hedge account, the final results are the same, but it was more confusing getting there than the preferred way I showed above.
Common Hedge Account Confusion - Example Market Carry
One of the most common mistakes I see farmers make when they start doing their own hedging is that they get lost in the math and forget where or why the position is what it is. Following is an example of that.
Let's say a farmer sold some corn for $4.00 last July. Then in November they rolled their futures forward to March to capture carry. On 11/29/17 when Dec corn was $3.36 and Mar was $3.50, a farmer would receive 14 cents of carry premium. In this example a farmer has actually sold corn for $4.14 against March. The $4.00 original sale plus the 14 cents of carry.
But two months later in January, panic sets in when the farmer is reviewing their hedge account statement and sees a sale of $3.50. How can this be? They never would sold at such a low level. They may think, "I must have made a mistake."
The farmer didn't make a mistake, they just forgot that they bought back their $4.00 Dec future sale at $3.36 in late November and then sold March futures for $3.50 to collect carry. They made the right trade all along and profited from the carry, they just needed to add that profit in the hedge account to their current position. So, a $4.00 sale bought back at $3.36 is a profit of 64 cents. If they take their current position of $3.50 sale against the March and add that 64 cents of profit from the Dec trade in their account they arrive at $4.14 ($3.50 .64)
While capturing carry is relatively simple and low risk, it can trip up farmers when they review their hedge accounts in the future. The only thing that matters with carry is the spread level between the two months. The actual price of the two months doesn't matter. Gains or losses from carry/spread trades don’t show up as a line item anywhere on the hedge statements. A farmer must keep detailed notes, otherwise it may be easy to forget these kind of details when reviewing trades or positions several months later.
The Importance Of Keeping Detailed Records
I never open a hedge account statement and assume I know what my cash corn value is by looking at the values listed. Instead, I start with a very detailed spreadsheet that shows every trade I make with the following details:
- What futures contract
- What % of production
- Which crop year it's hedged for
- Why I made the trade
Then when I roll my futures forward to collect carry, I enter each of those trades separately on their own line. That way I can see how much profit I made from carry/storage. I also detail out every basis trade so I can determine my final cash price.
Finally I keep track of every options trade I make throughout the year, just like I do with futures. All profits and losses from options must be add (or subtracted) to determine my final cash price.
Make The Right Trades And The Math Will Work Out
My top priority is making the right trades for my farm operation. I don't worry if I have a positive or negative trade in my hedge account. My hedge account doesn't always show the full story because it doesn't include the cash price I get from the end users. Instead, I keep detailed notes of all my trade independently to ensure profitability and minimize risk.
This process may sound complicated or overwhelming to some, but it's necessary and gets easier with practice. I also suggest running the math on every equation at least two or three times to make sure you have accounted for everything. You may also consider finding someone knowledgeable in grain marketing to help you navigate your position and check your math as well.
Superior Feed Ingredients, LLC
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