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 5, 1999

Minimizing Losses and Complicated Strategies

Gloom, doom and minimize losses. That seems to sum up a lot of the marketing information I’ve seen and heard recently. "Sick" exports and the prospects of increased ending stocks are among the major causes for the gloomy soybean outlook. November soybean futures closed at $5.27 on Thursday (2-4-99). Assuming a Central Missouri harvest basis of minus thirty-five cents, this results in a harvest price of about $4.92. This is not a price that offers much profit or a price that anyone really wants to lock-in. But it prices may get worse. Some analysts are already predicting soybean prices of $4.50 or less by harvest. This often leads to a discussion of risk management strategies which, at least, limit losses if profits aren’t possible.

What about using a put option to protect prices? A November $5.25 soybean put had a premium of $.33 (Thursday). Buying this put gives a floor price of about $4.57 ($5.25 strike price minus $.33 premium minus $.35 basis). This kind of floor only protects a loss for many producers! Most would prefer a strategy to protect profits.

Expect to see a lot of different "risk management strategies" suggested in the coming months as everyone tries to improve on low price bids. This week, one marketing program speaker suggested using a bear call strategy. This involves selling a call option to enhance the price (or offset the put premium) and then buying a further out-of-the-money call to limit risk if prices go up. For example, suppose a $5.50 call is sold for a premium of about $0.24 and a $6.00 call is purchased for $0.14 (Thursday closes). This would provide an additional $0.10 ($.24 premium collected for $5.50 call minus $.14 paid for $6.00 call). This would increase either the hedged price to $5.02 ($4.92 plus $.10) or the put option floor to $4.67 ($4.57 plus $.10). This strategy does limit some risks and adds to net price. However, it is a complicated strategy for a gain of only ten cents (actually a little less when broker commissions are included) and any prices between $5.50 and $6.00 (November futures) are given up.

Using spread trades and other combinations of strategies, similar to the above, may offer some risk management benefits. But they may not work for everyone. They can be complicated and require close attention and timing. It is also important to remember that "risk management doesn’t mean risk free." To be used successfully, it is important to understand exactly how the strategies work and what risks they contain.

While few risk management strategies are simple, some are less complicated. The market loan or LDP already provides a price floor near $5.25. Taking advantage of any spring price strength, to forward contract, and then being prepared to use the LDP may allow capturing prices for harvest delivery in the mid $5 range (or better) even if prices do fall into the mid $4 range by fall.

Marketing services and analysts will be offering a wide variety of suggested strategies to deal with low prices. Small losses are better than large losses, but it seems a little early to lock in prices just to minimize losses. However, the risk of low harvest price is very real and it looks like a variety of risk management tools are going to be necessary. Marketing decisions and choosing the right strategy may be very critical this year. -- Melvin


University of Missouri ExtensionDecisive Marketing - February 5, 1999
http://outreach.missouri.edu/agconnection/DCT/DM990205.html -- Revised: April 20, 2004
breesm@missouri.edu