Welcome to Moline’s Musings of Risk Management. Last time, I laid out a few scenarios talking about the risk of spring’s projected crop insurance prices being lower, especially for those with high inputs already locked in.
Today, I am going to spend a little time talking about a strategy that is tailored to the current price environment we see ourselves in.
Ultimately, as a farmer, we are looking for a strategy we could employ today to help protect us from prices going lower while having some higher-priced inputs locked in. I have one example built to show how it would fit into two different spring crop insurance price situations.
Implemented Hedging Strategy:
This strategy assumes the current futures value of December corn remains stable. In this strategy, we protect 85% of our APH, about halfway through a collar (also called a fence, risk reversal, or min-max strategy) and the other half through forward selling or selling December corn futures contracts. In this case, the collar consists of both buying a put option and selling a call option. As a farmer, we can implement the collar strategy through a brokerage account or through cash contracts that many grain buyers offer. The put protects us in lower price environments while the sold call helps pay for some, or sometimes, all of the premium needed to buy the put option. The sold call limits our upside potential but reduces or sometimes eliminates the premium we have to pay for the protection.
Here is how this strategy plays out:
Buy 100 bushels/acre of December $5.50 puts paying $0.38
Sell 100 bushels/acre of December corn $6.30 calls collecting $0.38
Sell 87 bushels/acre at the current futures level of $5.75
What Does Our P/L Matrix Look like if Feb Avg = $5.75?
Example highlighting the implemented hedge:
No strategy implemented:
You can see that this helps to protect the lower price portion of our matrix where we had only marginal profit per acre through revenue protection.
Insurance Pricing Scenario 2:
The second scenario highlights a move lower for spring crop insurance price, representing a projected price of $5.50. We are still employing the same hedging strategy from above and keeping all of the variables the same except for the February insurance price.
If our February average price ends up trending lower to $5.50, our P/L matrix does not look so good as a hedging strategy. With the strategy we have implemented, you can insulate yourself from most of this risk and drastically improve the profit per acre outcomes of your operation in lower-price environments. If prices move lower over the next month, having a hedging strategy implemented becomes even more important to your bottom line.
What Does Our P/L Matrix Look like if Feb Avg = $5.50?
Example highlighting the implemented hedge:
No strategy implemented
This is exactly what risk management means, taking opportunities when they present themselves and protecting yourself from downside price risk. But it takes a portfolio mindset to consider all the tools available to you in order to take action.
Producers who have been dedicated to forward selling grain as a part of their marketing plan (a practice I strongly condone), have been experiencing a heavy dose of sellers remorse. This happens about once every decade when a historic rally in the grains takes place, and it wreaks havoc on producer grain marketing habits over the next few years. As it turns out, the FOMO (Fear of Missing Out) is an extremely powerful emotion, often stronger than fear of downside risk, that can cloud objective decision-making. As an advisor, my plea to you is to maintain healthy marketing habits over this next year which include forward selling grain and diversifying the ways and timeframes in which you market grain.
I also believe it is best practice to have a system to track your cash sales and hedging through brokerage accounts in one place. Otherwise, you are making blind business decisions in a vacuum. Farmers Risk is one system that can track these details in a simple, user-friendly, web platform that ties your marketing picture together. It enables you to make decisions based on your operation’s profit/acre, rather than making marketing decisions without the knowledge of how it truly impacts your bottom line in every possible scenario. As a farmer, you need to know how your grain marketing plan performs in every possible situation. This tool allows you to see the complete picture. Most importantly, find something that works for your farm.
This material should be construed as the solicitation of trading strategies and/or services provided by Farmers Risk Inc. These materials represent the opinions and viewpoints of the author, and do not necessarily reflect the viewpoints and trading strategies employed by Farmers Risk Inc. The trading of derivatives such as futures and options involves substantial risk of loss and you should fully understand those risks prior to trading. Farmers Risk Inc. is not responsible for any redistribution of this material by third parties, or any trading decisions taken by persons not intended to view this material. Information contained herein was obtained from sources believed to be reliable, but is not guaranteed as to its accuracy.