Melvin Brees
Farm Management Specialist
University of Missouri Extension

 

 

 

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Please send your comments and send suggestions to Melvin Brees, Farm Management Specialist, University of Missouri Extension, #1 Courthouse Square,  Fayette, MO 65248, call 660-248-2272, or send messages by e-mail to: breesm@missouri.edu.
February 18, 2000

Marketing Tools for Risky Markets

It's shaping up to be a challenging marketing year for grain marketing. Big supplies, good demand, fluctuating export numbers and uncertain weather create risk. Most of the Corn Belt is dry, which could allow rapid planting of a large acreage leading to big production and lower prices. But the markets will also worry about dry weather continuing into summer, which could reduce production and result in significantly higher prices. Let's review how various marketing tools deal with these risks.

Forward cash contracts offer the best protection against lower prices because they fix both prices and basis. The major disadvantages, especially when used early in the season, are that they obligate us to deliver at the contracted price and specified quantity--even if production is reduced and/or prices go higher.

Hedging (selling with futures contracts) protects price but doesn't lock-in basis and so doesn't protect against a weak harvest time basis. However, a futures hedge offers more flexibility in that it is possible to get out of it (probably with some loss) and we avoid being locked in to a price and quantity delivery obligation. The major disadvantage is possibility of margin calls--maybe substantial margin calls if prices rally significantly. A hedge-to-arrive contract (with a local elevator) produces similar price results as the futures hedge and can be simpler to use, but it is somewhat less flexible.

Minimum price contracts or buying put options allow us to set price floors and still capture higher prices if they occur. A minimum price contract (with an elevator) allows setting a minimum price for a quantity with obligation to deliver. However, the elevator charges you a fee to offset the cost of providing the flexibility to capture higher prices. Buying a put option also allows us to set a price floor by providing the right to sell futures (or hedge) at a specified futures price. We aren't obligated to enter the hedge or deliver the grain, but we are out the cost (premium) of the option and it doesn't protect against a weaker basis.

Buying a call option in combination with a forward cash contract or futures hedge. The call provides the right to buy futures at a specified price or re-own grain that we might forward contract or hedge. This is what an elevator does when they write a minimum price contract. Buying the call provides "insurance against missing higher prices" and, while buying it ourselves is more complicated, may allow more flexibility in capturing higher prices.

Remember that spring price rallies often offer the best selling opportunities--especially for grain that must be moved at harvest! However, weather risks appear to be greater this year and it makes early season pricing decisions much more difficult. This situation suggests the need to understand and use flexible marketing tools, or a combination of tools, to deal with these risks.

-- Melvin


University of Missouri ExtensionDecisive Marketing - February 18, 2000
http://outreach.missouri.edu/agconnection/DCT/DM000218.html -- Revised: April 20, 2004
breesm@missouri.edu