Grain Marketing Basics Cash Grain Basis, Forward Contracts, Futures - PDF

Document Sample
Grain Marketing Basics Cash Grain Basis, Forward Contracts, Futures - PDF Powered By Docstoc
					                                                                                 Price Trend Effects
                                                                                 On Cash Sales & Forward Contracts
Grain Marketing Basics:                                                                  Pricing             Falling Rising Wider Narrower
                                                                                       Alternatives          Futures Futures Basis  Basis
Cash Grain Basis, Forward Contracts,                                              Cash Market Sales            (−)       (+)      (−)       (+)
Futures & Options                                                                 Forward Cash Contract       None     None None           None
                                                                                  Basis Contract               (−)       (+)     None      None
          Dr. Daniel M. O’Brien
                                                                                  Hedge-to-Arrive (HTA) None           None       (−)       (+)
          Extension Agricultural Economist
                                                                                  Minimum Price Contract      None       (+)     None      None
          K-State Research and Extension
                                                                                  Price Later Contract         (−)       (+)      (−)       (+)

                  2008 K-State Risk Assessed Marketing Workshops




Price Trend Effects                                                              Risk Exposure of Marketing Tools
On Futures, Options & Marketing Loans
                                                                                 A. Options Volatility Risk
        Pricing                Falling Rising Wider Narrower                           Risk that option premiums will not change 1-for-1 with
     Alternatives              Futures Futures Basis  Basis                            cash/futures as the price level changes                ?

Short Futures Hedge               None             None            (−)    (+)
                                                                                 B. Production Risk if Pre-harvest Pricing
                                                                                       Risk of being unable to deliver grain to fulfill a contract
Buy Put Options                   None               (+)           (−)    (+)
                                                                                 C. Counter Party Risk
Sell Cash & Buy Calls             None               (+)           None   None         Risk that a buyer wont fulfill their contract obligations

Marketing Loans                   None               (+)           (−)    (+)    D. Control Risk
                                                                                       Risk of market actions getting “out of control” before
                                                                                       corrective actions can be taken by the seller
Areas of Risk Exposure                                       Areas of Risk Exposure
For Cash Sales & Forward Contracts                           For Futures, Options & Marketing Loans

       Pricing                      Prodn. Counter
                                                                   Pricing                       Prodn. Counter
     Alternatives        Options     Risk if Party Control
                         Volatility Prehvst. Risk   Risk         Alternatives         Options Risk if Party Control
                                                                                      Volatility Prehvst. Risk  Risk
Cash Market Sales            ---       ---       ---   Yes
                                                             Short Futures Hedge         ---       Yes        ---      Yes
Forward Cash Contract        ---      Yes        Yes   ---
                                                             Buy Put Options            Yes        Yes        ---      Yes
Basis Contract               ---      Yes        Yes   Yes
                                                             Sell Cash & Buy Calls      Yes        ---        ---      Yes
Hedge-to-Arrive (HTA)        ---      Yes        Yes   Yes
                                                             Marketing Loans             ---       ---        ---      Yes
Minimum Price Contract      Yes       Yes        Yes   Yes
Price Later Contract         ---       ---       Yes   Yes




Hedging With Futures                                         Grain Forward Pricing Decisions
   Price Hedges on Grain Production                           How Much to Forward Contract or Hedge?
 1) (Prehedge) Analyze hedging opportunity                      For Pre-Harvest Pricing:
       Futures less Basis less Brokers’ fees                       Max of 50%-75% of expected production (average yields)
                                                                     If have a short crop, use Crop Insurance Coverage revenues
 2) (Placing the Hedge) Sell futures contract(s)                     to help fill Forward Contract obligations
    nearest to the grain delivery period                           Recommended: A disciplined grain marketing plan
       In a “Short” or “sell” futures position

 3) (Closing Out the Hedge Position)
                                                              What Time Period to Set Grain Delivery In?
                                                                Examine Harvest vs Post Harvest Basis, Storage
       Buy back futures contract(s)
                                                                Returns, and Grain Delivery Opportunities
       Sell cash grain (optional)
                                                                Timing of cash flow needs
Forward Contract Vs Futures Hedge                         New Crop DEC 2008 Corn
                                                          Examples for March 3, 2008
 If Basis Projection is Accurate, then..
   Forward Contract $ = Futures Hedge $                     CBOT December 2008 Corn Prices
 Who Carries the Futures Account?
   FC: Elevator contacts broker & pays any margin calls     Futures Hedge for Harvest Delivery
   Hedge: Producer works w. broker, pays margin calls
                                                            Forward Contract for Harvest Delivery
 Delivery Commitment?
   FC: Delivery commitment of X bushels for $X price
                                                            Put Option Price Floor
   Hedge: No delivery commitment to elevator
 Basis Commitment?                                          Call Option Price Coverage
   FC: Set cash basis / Hedge: Varying cash basis




CBOT DEC 2008 Corn                                        2008 Preharvest Corn Hedge
January 2006 – March 2008                                 Hedging on Monday, March 3, 2008
                                                            Target Sales Date: November 15, 2008
                                                            Corn Futures Price (3/3/08)
                                                              December ‘08 CBOT Corn = $5.76 1/2

                                                            Expected Corn Basis
                                                              $0.05-$0.25 under DEC CBOT Corn on November 15th

                                                            2008 Corn Hedge Expected Price = $5.58 /bu
                                                               DEC 08 CBOT Corn - Basis - Broker
                                                               $5.76 - $0.17 - $0.01 = $5.58
Cash Corn Basis: Dighton, KS                                                                                           Cash Corn Basis: Scott City, KS
Years 2005-2008                                                                                                        Years 2005-2008
                                                2008                        2007               2006             2005                                       2008                 2007                    2006                 2005

                                       $0.30                                                                                                      $0.30
                                       $0.20
            Basis (Cash - Futures)




                                                                                                                        Basis (Cash - Futures)
                                                                                                                                                  $0.20
                                       $0.10
                                                                                                                                                  $0.10
                                       $0.00
                                                                                                                                                  $0.00
                                      ($0.10)
                                      ($0.20)                                                                                                    ($0.10)

                                      ($0.30)                                                                                                    ($0.20)

                                      ($0.40)                                                                                                    ($0.30)
                                                   1       4       7    10 13 16 19 22 25 28 31 34 37 40 43 46                                             1      4   7   10   13   16   19   22   25   28   31   34   37   40    43    46
                                                                          Week of Year (Consecutive Order)                                                                     Week of Year (Consecutive Order)




Cash Milo Basis: Dighton, KS                                                                                           Cash Milo Basis: Scott City, KS
Years 2005-2008                                                                                                        Years 2005-2008
                                               2008                        2007              2006             2005                                         2008                 2007                    2006                     2005

                                     $0.10                                                                                                       $0.00

                                     $0.00
 Basis (Cash - Futures)




                                                                                                                                                 ($0.10)

                                                                                                                        Basis (Cash - Futures)
                                     ($0.10)
                                                                                                                                                 ($0.20)
                                     ($0.20)
                                                                                                                                                 ($0.30)
                                     ($0.30)
                                                                                                                                                 ($0.40)
                                     ($0.40)

                                     ($0.50)                                                                                                     ($0.50)

                                     ($0.60)                                                                                                     ($0.60)

                                     ($0.70)                                                                                                     ($0.70)
                                               1       4       7       10 13 16 19 22 25 28 31 34 37 40 43 46                                              1   4      7   10 13 16 19 22 25 28 31 34 37 40 43 46
                                                                           Week of Year (Consecutive Order)                                                                    Week of Year (Consecutive Order)
New Crop Corn Hedge Example                                              New Crop Corn Hedge Example
Scenario A: Falling Corn Prices                                          Scenario B: Rising Corn Prices

Date       Cash                    Futures                    Basis       Date      Cash                     Futures                     Basis
Expt. $: $5.58 ($5.76 - 0.18*)                                            Expt. $: $5.58 ($5.76 - 0.18*)
By November 15, 2008                                                      By November 15, 2008
On 3/3/08                          On 3/3/08                    Expt      On 3/3/08                          On 3/3/08                    Expt
No Cash Transactions               Sell DEC 08 @$5.76         ($0.18)     No Cash Transactions               Sell DEC 08 @$5.76         ($0.18)
On 11/15/08                        On 11/15/08                 Actual     On 11/15/08                        On 11/15/08                 Actual
Sell Cash Corn @ $3.58             Buy DEC 08 @$3.76          ($0.18)     Sell Cash Corn @ $7.58             Buy DEC 08 @$7.76          ($0.18)
                                   Net Gain/Loss on Futures:                                                 Net Gain/Loss on Futures:
                                   Gain of $2.00 /bu ( - $0.01 broker)                                       Loss of $2.00 /bu ( - $0.01 broker)
                    Final Net Price = $5.58 /bu                                              Final Net Price = $5.58 /bu
                  Cash $3.58 + $2.00 Futures Gain                                          Cash $7.58 – $2.00 Futures Loss




2008 New Crop Corn Forward Contract                                      2008 New Crop Milo Forward Contract
Utica, Kansas                                                            Utica, Kansas
 Garden City Coop, Utica, Kansas                                          Garden City Coop, Utica, Kansas
 Mar. 5, 2007 – Feb. 29, 2008                                             Mar. 5, 2007 – Feb. 29, 2008
 Source: DTN Bid Analyzer                                                 Source: DTN Bid Analyzer


                  $5.47 /bu on 2/29/08                                                          $5.15 /bu on 2/29/08
                  FC Basis: $0.18 /bu under                                                     FC Basis: $0.50 /bu under
                  CBOT DEC 2008 Corn Futures                                                    CBOT DEC 2008 Corn Futures
DEC 2008 Corn Put-Call Option Prices                                                                                 DEC 2008 Corn Put Option Values
                                                                                                                                      $1.50
                 $1.50                                                                                                                                                    DEC 2008 Corn Futures Close:
                                                                     DEC 2008 Corn Futures Close:
                                                                     $5.76 /bu on March 3, 2008                                                                           $5.76 /bu on March 3, 2008
                                                                                                                                      $1.20                                                                                          "In the Money" Puts:




                                                                                                                     Premiums / Bu.
                                                                                                                                                                                                                                          Futures < SP
Premiums / Bu.




                            $0.95 $0.92                                                                                                                                        "Out of the Money" Puts:
                                               $0.85 $0.84 $0.76                                                                                                                     Futures > SP
                                                                                                                                      $0.90
                                                         $0.74       $0.75
                 $0.75                                                       $0.70 $0.68
                                  $0.55     $0.59 $0.65                                              $0.60
                                                                                                             $0.54                    $0.60
                         $0.49


                                                                                                                                      $0.30


                 $0.00                                                                                                                $0.00
                          $5.30 $5.40 $5.50 $5.60 $5.70 $5.80 $5.90 $6.00 $6.10 $6.20 $6.30                                                                $5.30         $5.40             $5.50       $5.60        $5.70           $5.80              5.9
                                                              Strike Prices                                                                                                                        Strike Prices
                                         Put Option Premiums                    Call Option Premiums                                                                Put Time Value                                  Put Intrinsic Value




DEC 2008 Corn Put Price Floors                                                                                       Results of Buying a $5.30 DEC 2008
                 $7.00
                                                                                                                     Corn Put Option @ $0.49/bu
                                                  At the Money: $5.76 /bu (3/3/08)
                 $6.00                                                                                                                            $9.00
                                                             0.59         0.65         0.74                                                                                                                                                    $7.08
Premiums / Bu.




                 $5.00           0.49           0.55                                                                                                                                                                               $6.58           $6.57



                                                                                                                               Net Returns / Bu
                                 0.18           0.18         0.18            0.18          0.18                                                   $7.00                                                                $6.08           $6.07
                                                                                                                                                                                                           $5.58           $5.57
                 $4.00
                                                                                                                                                               $5.07       $5.07                 $5.07
                                                                                                                                                                                       $5.07 $5.08             $5.07
                                                                                                                                                                                   $4.58
                                                                                                                                                  $5.00                $4.08
                                                                                                                                                           $3.58
                 $3.00
                                                                                           $4.76
                                                             $4.71



                                                                             $4.75
                                                $4.65
                                 $4.61




                                                                                                                                                  $3.00
                 $2.00
                                                                                                                                                  $1.00
                 $1.00
                                                                                                                                                  -$1.00
                 $0.00
                             $5.30             $5.40        $5.50        $5.60         $5.70            $5.80                                               $3.76       $4.26       $4.76          $5.26    $5.76       $6.26       $6.76       $7.26
                                                             Strike Prices                                                                                                                         Futures Prices
                                 Floor Price*            Basis        Put Premium                  Broker Fee                                                 Cash Price                    Net Put Return                 Net Price Received
DEC 2008 Corn Call Option Values                                                                                                     DEC 2008 Corn Call Price Coverage
                                                                                                                                     Minimum Price Increase Needed to Cover Call Premium Cost
                  $1.50                                                                                                                               $9.00
                                                                                   DEC 2008 Corn Futures Close:                                                                                              At the Money: $5.76 /bu (3/3/08)
                                           In the Money Calls:                     $5.76 /bu on March 3, 2008                                         $7.50
                  $1.20                        Futures > SP
Premiums / Bu.




                                                                                                                                     Premiums / Bu.
                                                                                                                                                                                                                             0.68       0.60     0.54
                                                                                               Out of the Money Calls:                                $6.00                                0.84            0.75     0.70
                                                                                                    Futures < SP                                              0.95       0.92     0.85
                  $0.90
                                                                                                                                                      $4.50




                                                                                                                                                                                                                                                  $6.30
                                                                                                                                                                                                                                         $6.20
                  $0.60




                                                                                                                                                                                                                              $6.00
                                                                                                                                                                                                                     $5.90
                                                                                                                                                                                                            $5.80
                                                                                                                                                                                            $5.60
                                                                                                                                                                                   $5.50
                                                                                                                                                                          $5.40
                                                                                                                                                               $5.30
                                                                                                                                                      $3.00

                  $0.30
                                                                                                                                                      $1.50

                  $0.00                                                                                                                               $0.00
                                   $5.30 $5.40 $5.50 $5.60 $5.70 $5.80 $5.90 $6.00 $6.10 $6.20 $6.30                                                          $5.30 $5.40 $5.50 $5.60 $5.70 $5.80 $5.90 $6.00 $6.10 $6.20 $6.30

                                                                           Strike Prices                                                                                                               Strike Prices
                                            Call Time Value                                    Call Intrinsic Value                                                    Strike Price                 Call Option Premiums              Broker Fee




Results of Buying a $5.80 DEC 2008                                                                                                   New Crop NOV 2008 Soybeans
Corn Call Option @ $0.75 /bu                                                                                                         Examples for March 3, 2008
                              $4.50
                                       DEC 2008 Corn Futures Close:                                                                                   CBOT November 2008 Soybean Prices
                                           $5.76 /bu on 2/26/08
           Net Returns / Bu




                              $3.00
                                                                                                                          $2.00

                              $1.50                                                                $1.00
                                                                                                               $1.50         $1.23                    Basis History (2005-2008)
                                                                                                                  $0.73
                                                                                       $0.50
                                                                                                      $0.23
                              $0.00                                                                                                                   Futures Hedge for Harvest Delivery
                                                                                         ($0.27)
                                         ($0.77)     ($0.77)     ($0.77)     ($0.77)
                              -$1.50
                                       $4.26       $4.76       $5.26       $5.76       $6.26       $6.76       $7.26      $7.76                       Put & Call Option Premiums
                                                                           Futures Prices
             Call Purchase Price                       Call Selling Price              Broker Fee             Net Call Returns
CBOT NOV 2008 Soybeans                                                                         Cash Soybean Basis: Dighton, KS
January 2006 – March 2008                                                                      Years 2005-2008
                                                                                                                                   2008              2007            2006             2005

                                                                                                                         $0.00

                                                                                                                         ($0.20)




                                                                                                Basis (Cash - Futures)
                                                                                                                         ($0.40)

                                                                                                                         ($0.60)

                                                                                                                         ($0.80)

                                                                                                                         ($1.00)

                                                                                                                         ($1.20)

                                                                                                                         ($1.40)

                                                                                                                         ($1.60)
                                                                                                                                   1   4     7   10 13 16 19 22 25 28 31 34 37 40 43 46
                                                                                                                                                   Week of Year (Consecutive Order)




Cash Soybean Basis: Scott City, KS                                                             2008 New Crop Soybean Frwd. Contract
Years 2005-2008
                                                                                               Utica, Kansas
                                    2008            2007                 2006           2005
                                                                                               Garden City Coop, Utica, Kansas
                          $0.00                                                                Mar. 5, 2007 – Feb. 29, 2008
                          ($0.20)                                                              Source: DTN Bid Analyzer
 Basis (Cash - Futures)




                          ($0.40)

                          ($0.60)                                                                                                         $13.14 /bu on 2/29/08
                                                                                                                                          FC Basis: $1.10 /bu under
                          ($0.80)
                                                                                                                                          CBOT NOV 2008 Soybean Futures
                          ($1.00)

                          ($1.20)

                          ($1.40)

                          ($1.60)

                                    1   4   7   10 13 16 19 22 25 28 31 34 37 40 43 46
                                                     Week of Year (Consecutive Order)
NOV ‘08 Soybean Put-Call Option $s                                                                                             NOV 2008 Soybean Put Price Floors
                     $3.00                                                                                                                      $18.00
                                                                                    NOV 2008 CBOT Soybean Close:                                                               At the Money: $14.47 1/2 /bu
                                $2.40                                               $14.47 /bu on March 3, 2008
                                                                                                                                                $15.00
                                                            $2.10 $2.15




                                                                                                                               Premiums / Bu.
    Premiums / Bu.




                                                                                                                                                                              1.56          1.63        1.77
                                                                                                                                                          1.34      1.43
                     $2.00                                                                           $1.78                                      $12.00    1.10      1.10      1.10          1.10        1.10
                                                         $1.63 $1.77                                                   $1.72
                                                 $1.56
                                      $1.43
                             $1.34                                                                                                               $9.00




                                                                                                                                                                                                        $11.31
                                                                                                                                                                                            $11.25
                                                                                                                                                                              $11.12
                                                                                                                                                                    $11.05
                                                                                                                                                          $10.94
                     $1.00                                                                                                                       $6.00

                                                                                                                                                 $3.00

                     $0.00                                                                                                                       $0.00
                              $13.40 $13.60 $13.80 $14.00 $14.20 $14.40 $14.60 $14.80 $15.00 $15.20 $15.40                                               $13.40    $13.60    $13.80       $14.00       $14.20    $14.40   $14.50

                                                                      Strike Prices                                                                                                    Strike Prices
                                               Put Option Premiums                     Call Option Premiums                                               Floor Price*        Basis           Put Premium           Broker Fee




   NOV 2008 Soybean Call Price Coverage                                                                                        New Crop July 2008 HRW Wheat
   Minimum Price Increase Needed to Cover Call Premium Cost
                                                                                                                               Examples for March 3, 2008
                 $21.00
                                 At the Money: $14.47 1/2 /bu (3/3/08)
                 $18.00
                                                                                            1.78              1.72                              KCBT July 2008 HRW Wheat Prices
Premiums / Bu.




                 $15.00                                   2.10             2.15
                                      2.40

                 $12.00
                                                                                                                                                Basis History (2005-2008)
                                                                                                              $15.40
                                                                                            $15.00
                                                                           $14.20
                                                          $14.00




                     $9.00
                                      $13.40




                     $6.00
                                                                                                                                                Futures Hedge for Harvest Delivery
                     $3.00

                     $0.00
                                     $13.40              $14.00           $14.20          $15.00             $15.40
                                                                                                                                                Put & Call Option Premiums (2/22/08)
                                                                      Strike Prices
                                     Strike Price                  Call Option Premiums                 Broker Fee
KCBT JULY 2008 HRW Wheat                                                                        Cash Wheat Basis: Dighton, KS
February 2007 – March 2008                                                                      Years 2005-2008
                                                                                                                                        2008             2007              2006              2005

                                                                                                                          $0.00




                                                                                                 Basis (Cash - Futures)
                                                                                                                          ($0.20)

                                                                                                                          ($0.40)

                                                                                                                          ($0.60)

                                                                                                                          ($0.80)

                                                                                                                          ($1.00)

                                                                                                                          ($1.20)

                                                                                                                          ($1.40)
                                                                                                                                    1     4    7   10 13 16 19 22 25 28 31 34 37 40 43 46
                                                                                                                                                     Weeks during Year (Consecutive Order)




Cash Wheat Basis: Scott City, KS                                                                2008 New Crop Wheat Frwd. Contract
Years 2005-2008
                                                                                                Utica, Kansas
                                    2008               2007              2006            2005
                                                                                                Garden City Coop, Utica, Kansas
                                                                                                March 5, 2007 – Feb. 29, 2008
                          $0.00
                                                                                                Source: DTN Bid Analyzer
                          ($0.20)
 Basis (Cash - Futures)




                          ($0.40)

                          ($0.60)

                          ($0.80)

                          ($1.00)

                          ($1.20)                                                                                                                                   $10.30 /bu on 2/29/08
                                                                                                                                                                    FC Basis: $0.60 /bu under
                                    1      4   7   10 13 16 19 22 25 28 31 34 37 40 43 46
                                                                                                                                                                    KC July 2008 Wheat Futures
                                                      Week of Year (Consecutive Order)
JULY ‘08 HRW Wheat Put-Call Option $s                                                                                                             JULY 2008 KC Wheat Put Price Floors
                 $2.10                                                                                                                                          $15.00
                              JULY 2008 KCBT Wheat Close:                                                                                                                  At the Money: $10.99 /bu (3/3/08)
                               $10.99 /bu on March 3, 2008
                                                                                                                                                                $12.00




                                                                                                                                               Premiums / Bu.
                           1.42                                                                                                    1.43
Premiums / Bu.




                                        1.37                                                                            1.37                                                                                            1.14      1.25     1.37     1.43
                                                     1.32                                                                                                                 0.88     0.93     0.98      1.03     1.08
                 $1.40                                           1.27      1.22                   1.25                                                                             0.60     0.60      0.60     0.60     0.60      0.60     0.60     0.60
                                                                                                                                                                          0.60
                                                                                       1.141.13                                                                  $9.00
                                                                        1.03 1.08                         1.04 1.00
                                                 0.93       0.98                                                            0.96        0.92
                                     0.88
                                                                                                                                                                 $6.00




                                                                                                                                                                                                                                                    $9.45
                                                                                                                                                                                                                                  $9.33

                                                                                                                                                                                                                                           $9.41
                                                                                                                                                                                                                         $9.24
                                                                                                                                                                                                      $9.15

                                                                                                                                                                                                               $9.20
                                                                                                                                                                                   $9.05

                                                                                                                                                                                            $9.10
                                                                                                                                                                          $9.00
                 $0.70
                                                                                                                                                                 $3.00


                 $0.00                                                                                                                                           $0.00
                          $10.40 $10.50 $10.60 $10.70 $10.80 $10.90 $11.00 $11.20 $11.30 $11.40 $11.50                                                                   $10.50   $10.60   $10.70    $10.80   $10.90   $11.00    $11.20   $11.40   $11.50

                                                                            Strike Prices                                                                                                                Strike Prices
                                        Put Option Premiums                                     Call Option Premiums                                                       Floor Price*             Basis        Put Premium              Broker Fee




JULY ‘08 KC Wheat Call Price Coverage
Minimum Price Increase Needed to Cover Call Premium Cost                                                                                          Concluding Thoughts
                 $15.00


                 $12.00
                             At the Money: $10.99 /bu (3/3/08)

                                                                                                 1.04        1.00       0.96       0.92
                                                                                                                                                  on Grain Marketing
                                                        1.32       1.27      1.22      1.13
                                            1.37
Premiums / Bu.




                            1.15

                  $9.00
                                                                                                                                                  Goals, Plans & Strategies
                                                                                                                                    $11.50
                                                                                                                        $11.40
                                                                                                             $11.30
                                                                                                 $11.20
                                                                                       $11.00
                                                                              $10.80
                                                                   $10.70
                                                        $10.60
                                            $10.50
                            $10.40




                  $6.00


                  $3.00


                  $0.00
                          $10.40 $10.50 $10.60 $10.70 $10.80 $11.00 $11.20 $11.30 $11.40 $11.50

                                                                            Strike Prices
                               Strike Price                         Call Option Premiums                              Broker Fee
Goals in Grain Marketing                                   Improving the Selling Price of Grain
A. Price Improvement                                        Farmer’s Most Common Marketing Goal:
     To raise average grain selling price                      To improve average grain selling price!
B. Price Risk Reduction                                       To maximize grain selling price subject to the
     To reduce seller’s downside price risk                   need to manage harmful downside price risk

C. Average Pricing via Sequential Sales                     Specific Goals: Getting better than the...
D. Financial Management Oriented Goals                         Average price available
     Enterprise cost or whole farm profit objectives           Middle (50%) price available
                                                               Harvest price
E. Combination Goals
     Difficult to enhance price AND reduce risk




Reducing Grain Price Risk                                  Average Pricing via Sequential Sales
A. Goal: Reducing price risk by protecting                  Deliberately pricing portions of the crop at
   from harmful price moves                                 different times of the marketing year
     To maximize grain selling price subject to the need
     to manage harmful downside price risk                  Average Pricing….
B. Grain Sellers are motivated to:                           (+) AVOIDS selling 100% at market LOWS
     Protect themselves from downside price risk             (–) ALSO AVOIDS selling 100% at market HIGHS
     Possibility profit from price increases
                                                            Benefits of Average Pricing:
C. Tools for Reducing Grain Price Risk:                       Adds structure & discipline to marketing plans
     Forward Contracts & Hedges: To lock in prices            Is a form of price risk management
     MPCs & Put Options: To set price floors
Combining Grain Marketing Goals                                               Types of Grain Marketing Strategies
 Difficult to both Enhance Prices & Reduce                                    1) Routine Strategies
 Price Risk at the same time                                                       Grain marketed each year at the same time using the
                                                                                   same marketing tools regardless of market conditions
   Example: Higher returns & price variability from pre-
                                                                                  • Example: Preharvest hedge 1/3 of exp. production,
   harvest futures hedges vs. buying put options
                                                                                     sell 1/3 at harvest, store rest on farm for 6 months
                                                                                     then sell
 Principle of Price Risk Management
   Higher net grain selling prices will tend to be                            2) Systematic Strategies
   sacrificed in terms of lost pricing opportunities or                            Allowing for yearly variation in marketing actions
   the cost of managing price risk                                                 based on Key Market Indicators
   If Prices    : Cash Sales > Options-Fwd. Contracts                             •   Key #1: Preharvest Prices vs. CCC Loan Rates
   If Prices    : Fwd. Contracts > Options-Cash Sales                             •   Key #2: Years following Short Crops




Types of Grain Mktg. Strategies (more)                                        How Efficient are Grain Futures
3) Strategies Using Expert Forecasts                                          Markets at Determining Grain Prices?
     When people profit from their superior ability to forecast
     grain market trends & marketing decisions                                 How Efficient are Grain Markets?
    •   In general, it is difficult for individuals to predict market price
        direction better than other market participants                          Define “Market Efficiency”
                                                                                 Opinions: From Very to Moderately Efficient
4) Strategies Using Market-Based Forecasts
     Using futures, options & basis information as key                           Key Issue: “Do Grain Marketing Strategies Exist
     market indicators for making marketing decisions                            that are more profitable than selling at harvest?”
    •   Key #1: “Wide” Cash Grain Basis @ harvest
    •   Key #2: “Higher / Lower than normal” preharvest                        The degree of Futures Market Efficiency will
        hedge profits                                                          affect choice of Grain Marketing Strategies
Marketing Challenges & Benefits                                         Futures Margins
A. The Challenge of Grain Marketing Decisions                            Initial Margin Deposit:
        It is Difficult to obtain higher grain selling prices!!            Required up front, good faith deposit by exchanges
B. Grain Marketing’s Relative Importance                                 Margin Account
        (K-State Study of KFMA Farms for 1987-1996)

       High 1/3 vs Middle 1/3:                                             Losses/gains in futures position reflected here
       Yields: +17%; Costs: –37%; Prices +12%, More Notill                 Minimum required margin account balance
       Low 1/3 vs Middle 1/3:                                            Margin Deposit
       Yields: –18%; Costs: +28%; Prices –12%, Less Notill
                                                                           Additional money required when margin account falls
       Study Critique: Not measuring effectiveness of                      below minimum balance due to losses in futures position
       marketing practices used, only Hi/Lo Profit

C. Production is 1st priority; Marketing #1.A




Wheat Margin Deposit Example
Sell 5,000 bu July KCBT Wheat @ $10.50/bu on 2/5/08

      Prices Trend Up                       Prices Trend Down
                                                                                 Questions or Comments?
2/5:Sell $10.50 KC July Wheat         2/5:Sell $10.50 KC July Wheat
 Initial Deposit      = $1,500         Initial Deposit      = $1,500          K-State Agricultural Economics
 Minimum Deposit       = $1,000        Minimum Deposit       = $1,000
6/1: KC July Wheat @ $11.50   6/1- KC July Wheat @ $9.50
                                                                                   Department Website:
  Loss in Futures    ($5,000)   Gain in Futures    +$5,000                          www.Agmanager.Info
  Account balance    ($3,500)   Account balance     $6,500
  Margin Call       +$4,500     Margin Call       =$ 0
New Account balance = $1,000 New Account balance = $6,500