Why I Don't Use Minimum Price Contracts
Nov 06, 2017
Market Commentary for 11/3/17
The markets didn't move much this week. Harvest pressure continues to limit corn upside potential. Beans at first looked like they may take off as harvest slowed, but on Friday, Brazil's currency fell against the dollar. This meant a price boost for Brazilian farmers who sold some beans, putting pressure on futures prices. The 30 day forecast for South America looks good for growing beans. The market continues to search for a reason to swing either way right now.
Even though I'm hoping corn prices go up, I still think corn prices are going nowhere for a while. That's why I sold more calls, so I can presumably collect some premium in the meantime while I wait for other opportunities down the road to sell the grain and/or more options.
3 - New Trades - Selling Calls
On 10/24/17 when Dec corn was near $3.50 I sold the following calls for 10% of my production each:
- Jan $3.60 call for 10 cents – expires Dec 22nd
- May $3.70 call for 19 cents – expires Apr 20th
- July $3.80 call for 19 cents – expires June 22nd
What Does This Mean?
- If corn is trading below the strike price (the price listed on each line) when these options expire - I keep the premium and add it to another trade down the road.
- If corn is trading above the strike price (the price listed on each line) when these options expire - I have to sell corn for the strike price PLUS the premium.
Should corn rally above each of these prices I would receive an average price of $3.86 ($3.70 average 16 cents of options premium). I also will need to move some grain during these time periods to keep my stored grain in good condition, so this won’t be the worst thing if it happens.
While I don't really want to sell for $3.86, it means prices rallied, which is a good thing because I can then sell more of my unpriced corn at higher levels. I'm actually more concerned if corn prices DON'T rally. Like many farmers, I still have a substantial amount of unpriced grain that needs higher prices. So, until a rally comes, I need to "manufacture" prices that get me to profitable levels, and in this case, if prices remain low I can add to a later trade. This helps me push closer to breakeven points and profitable levels.
Why I Dislike Minimum Price Contracts
Right now some farmers are selling grain and then BUYING the calls I just sold in the above trades. Their guaranteed average price on all of these contracts would be $3.54. That comes from the average cost of the 3 calls at 16 cents, which will then need to be subtracted from the average sale price of the 3 contract prices above, or $3.70, to establish where their true minimum price starts. One benefit of this type of trade is unlimited upside potential, if the market rallies. But if the market doesn't rally, like this previous year, the farmer is behind.
If we compare my sold call trades above to the farmers buying those calls, the farmers buying calls would need corn to go higher than $4.02 to beat my $3.86 trade because they still need to recoup the 16 cent cost of buying the calls.
Rebuttal #1 - I'm sure some will argue that the calls could still have some time value left if there was a rally to $4, meaning the calls would be worth more than the 16 cent average. While that is a possibility, last year's futures struggled to keep the nearby futures price above $3.80 for any length of time, so I would argue $4 might be difficult this year. That argument also assumes that a farmer would sell the call before it expires when this time value is still in place. That is usually not something I see most farmers having the discipline to do. I know I would find it extremely hard to sell the call into a rally well before it expires.
Rebuttal #2 - Farmers buying a minimum priced contract will protect their downside, while my downside is open. Looking at the numbers though, corn prices would have to stay below $3.38, which is the minimum price contract floor of $3.54 less the 16 cent call premium I will collect, for me to be in worst shape than the farmer buying the call as part of the minimum price contract. While this could happen, I don't think $3.38 for a prolonged time period is all that likely, especially during the January to June time frame which is historically usually the higher priced months of the marketing year. Plus, I can still sell additional calls in the future as these expire to add more premium to these trades, should this scenario happen.
Generally speaking, after running the numbers for the various market scenarios that could happen, or are likely to happen, there just aren't a lot of advantages for me to sell grain and buy calls, and in most cases a farmer doing so will end up behind because those type of trades are often long shots. That being said, there are many different ways to look at the market. A lot of farmers want unlimited upside potential, especially with downside protection, but there is a cost to get that chance. It may mean selling at levels below today’s already disappointing prices. The market has been range-bound for over a year now and could be in one for another year, so I try to structure some of my trades to be most profitable knowing this....I don’t want to be chasing long shots.
Superior Feed Ingredients, LLC
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