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.
October 20, 2000

Collect the LDP, Limit Risk With a Put

Central Missouri Cash corn bids averaged about $1.64 on Thursday (10-19-00). This represents a very weak basis of minus $0.42 ($1.64 Cash Price minus $2.06 Dec. Futures). Adding in the $0.23 LDP (loan deficiency payment) makes the net sale price $1.87. Market advisors are advising taking the LDP. Many of you would like to continue storing the corn to capture basis recovery and perhaps higher prices. If you claim (or already have claimed) the LDP, you no longer have the downside price protection the market loan program offers.

A put option can provide downside corn price protection. The March 2001 corn futures contract offers a $0.11 premium (market carry) over the nearby contract ($2.17 March vs. $2.06 Dec.). A March $2.10 (strike price) corn put option had a premium (cost) of about six cents. Purchasing this put would, in effect, lock-in about four cents of the market carry ($2.10 March put vs. $2.06 Dec. futures). This would offset more than half of the premium cost while leaving open the opportunity to get higher prices.

To illustrate this strategy, suppose you claim the $0.23 LDP, purchase the $2.10 put option and store the corn--planning on a January cash sale. What would your January "expected floor price" be? The past two years have seen Central Missouri corn basis recover (strengthen) by an average of fourteen cents from October to January. Assuming a similar recovery this year, January Central Missouri basis would be about minus $0.28 (-$0.42 current basis plus $0.14). This produces a January floor price of about $1.76 ($2.10 put strike price minus $0.28 basis minus $0.06 option premium). Adding in the previously collected LDP of $0.23 results in a corn price of $1.99 compared to the current net sale price of $1.87 or a "protected" minimum storage return of twelve cents!

Note that this example did not include storage cost calculations. The twelve-cent storage return would likely more than cover on-farm storage costs. Assuming ten percent interest rates and commercial storage charges of twelve cents per bushel (3 month minimum), the commercial storage costs would be about $0.16 per bushel. The put option limits the risk of speculating on higher prices for commercially stored corn to about four cents per bushel ($0.12 minimum return minus $0.16 storage costs).

The situation is similar for soybeans. Central MO cash bids of about $4.30 represents a weak minus $0.41 basis ($4.30 cash minus $4.71 Nov. futures). The $0.95 LDP produces a net sale price nearly equal to CCC loan price at $5.25. Assuming a similar Central MO basis recovery to the past two years of about sixteen cents results in an expected January basis of about minus $0.25. Buying a March $4.80 put option, at a premium of $0.15, results in a "protected" January cash price of $4.40 ($4.80 strike price minus $0.25 basis minus $0.15 option premium). Adding in the current $0.95 LDP produces a "net protected price" $5.35 before subtracting storage costs.

Collecting the LDP when basis and price are weak attempts to maximize the LDP, but results in downside price risk if you continue to store the grain. Purchasing a put option protects a small return for on-farm storage or limits the risk in commercial storage while continuing to speculate on higher prices with stored grain. --Melvin


University of Missouri ExtensionDecisive Marketing - October 20, 2000
http://outreach.missouri.edu/agconnection/DCT/DM001020.html -- Revised: April 20, 2004
breesm@missouri.edu