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.
July 21, 2000

Double Short Position?

The other day I had a telephone visit with a farmer to discuss a fall marketing strategy that had been suggested to him. While corn prices are low, he was very bearish in his price expectations and was expecting even lower corn prices this fall due to a huge corn crop. The strategy was to forward contract corn at about $1.70 and buy a $2.00 December corn put option for around ten cents. He believed that lower prices would result in a lower harvest time price than the contracted $1.70 and produce a larger LDP. The larger LDP would enhance the $1.70 contracted price significantly above the loan price. Adding in the potential gain from the put option might produce a net price in excess of $2.50! Sounds good, but what are the risks?

Whether you are bullish or bearish, it is always important to consider "What if I'm wrong?" While there is no further obligation with the put purchase, the above strategy approaches what could be called a "double short" position. Forward contracting corn would make the producer sold (short) the cash market. Purchasing the put option would also give him the right to sell (go short) the futures market. This is not a hedge! He would be short both the cash and futures markets. It is a short speculative strategy that is actually speculating on profiting from lower prices. What happens if prices are not lower at harvest time?

What if prices stay about the same? The farmer would be out the put premium and the put would likely expire worthless, since there would be little or no value for exercising it. He would receive the forward contracted price which would be about the same as harvest cash prices and the LDP would be determined by a similar Posted County Price (PCP). His net price would be approximately ten cents (the put purchase premium) less than loan price (net price = contracted price + the LDP - the put premium).

What if prices are higher at harvest? The net price could be much less than loan price. His $1.70 contracted price would be less than harvest cash prices if prices go up. The LDP would be less than planned or possibly non-existent if prices were higher and he would be out the put premium. This could produce a net price as low as $1.60 if there is no LDP ($1.70 contracted price minus $0.10 put premium).

There are other strategies that could enhance a lower price while reducing the risk of missing higher prices. One would be to buy only the put option. If prices drop, it would result in a net cash above loan price (net price = cash price + LDP + option gain). If prices increase, you would only be out the option premium and could still sell at higher cash prices. Another alternative would be to forward contract the cash corn and buy a call option. If prices fall, the Larger LDP would enhance the contracted price. If prices rise, gains on the call option would offset some of the LDP losses.

If you are confident that prices will be lower and accept the risks, a "double short" type of strategy might produce higher returns. Understand that prices are difficult to predict and while they can go down, prices can also go up or they might stay about the same. In the above strategy, two out of the three outcomes are bad. --Melvin


University of Missouri ExtensionDecisive Marketing - July 21, 2000
http://outreach.missouri.edu/agconnection/DCT/DM000721.html -- Revised: April 20, 2004
breesm@missouri.edu