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Hedging to maximize farm profitability with tight margins

Soybeans

Due to heavy rain, 6 million soybean acres in Kansas and Missouri are not yet planted. How many acres might end up in prevent plant? Two million acres, or about 100 million bushels, while significant would probably not have that large of an effect on the market. Even if none of these acres are planted, the 2015 carryout will still be higher than 2014.

Total planted acres estimates are still uncertain. USDA estimates 84 million while others forecast 87 million. Prevent plant acres will also influence the market. With so many unanswered questions, $8 to $10 is likely the range for now.

 

Corn

Social media and news reports make it sound like flooding is widespread throughout the Midwest, which is contradicting USDA weekly reports of 75% good to excellent corn crop overall. Many farmers, who initially reported yellow/uneven corn, are now seeing the warm weather and nitrogen take effect and corn appearances are improving.

Many forget the reports of “ponding” the last two years at this stage of growing. While flooding is unpleasant for a few (me included, we had to replant some acres), those on higher ground raise even better crops with higher yields. This level of flooding will likely only keep national bushel levels from breaking records, not cause a supply issue or a significant price rally based upon conditions today.

Another consideration, the heavy rains in the South has created fantastic pasture and grass situations for cattle. There has been a significant decrease in feed usage from clients in southern states. I expect the USDA to adjust feed usage demand estimates down the road.

Recently the USDA indicated the world corn carryout for the current year is higher than previously estimated, which will limit corn futures going forward. Rationale for potential rallies is getting less and less. Corn could trade as low as $3 at harvest, while upside new crop potential may be around $4.25 to $4.40. Obviously a drought in July can change this, but based upon what we know today this is what the market will have to trade.

 

Hedging

How does hedging work?

I get this question from farmers frequently. For those that have never done it, the process sounds scary and complicated. Unfortunately, this fear and lack of understanding keeps farmers from taking advantage of something that was specifically developed and designed for them to reduce their risk from market volatility and potentially increase profits. Following provides a more detailed explanation to demystify the process. (Note, I’ve included some general timing for explanation purposes only to understand the process, with hedging grain sales timing is very flexible and will vary year to year.)

 

January 1 2014  before planting: Determine breakevens and profit potential analysis

First step: pick a price on futures board I’m willing to sell the grain I will produce. This works best if farmers analyze average inputs and yields to determine a profit potential analysis. This runs contrary to many farmers’ thinking, which is to wait for the “best” price they think they can get after they produce the grain and sell. Rather, I recommend farmers determine what their desired price based upon breakeven points.

 

Spring and summer 2014: Sold my grain against futures price (CBOT)

Since harvest is in Oct, I typically recommend using Nov futures when pricing my grain before harvest, which is the closest futures contract month and the most commonly traded contract on CBOT for soybeans.

Example: Last June soybean prices were mid-$11s on Nov futures. I didn’t sell all my beans at once, but a percentage of my beans over several months. In the end, my average sale price was $11.47 on Nov futures. This means, last Summer I SOLD Nov future contracts in our hedge account through the CBOT.

 

Harvest 2014: Established market carry

At harvest I recommend reviewing futures markets to determine the best potential for the grain I just produced. Just because I sold against Nov futures doesn’t mean I actually have to deliver my grain then. That’s one of the reasons trading futures is so beneficial to farmers, the flexibility to consider market condition variations.

Example:

Step 1 — Last harvest I determined that storing grain was the most profitable. The Nov futures were valued LESS than July futures (or a 32 cent Market Carry to hold beans until July).

Step 2 — To get this premium I bought back Nov soybean futures for $9.35. Once I bought back the grain, the difference ($11.47-$9.35 = $2.15) was factored within my hedge account. That $2.12 amount is profit to me. I’ll come back to that later.

Step 3 — Sold beans against July futures for $9.67 at the same time as step 2. So, I bought beans back for $9.35 and resold them for $9.67 (32 cents premium).

This part trips up most beginning hedgers. I sold my grain in summer (against Nov), bought back that grain (in Nov futures) and took the profit. Then I sold it again against July (in November) to pick up the Market Carry premium. The first Nov futures sale and buy back cancel each other out, leaving me with the July sale only.

 

June 2015: Established basis

June 1 I set my basis (difference between CBOT and the local cash price available in my area) and established a cash price and delivery date for my grain.

Example: This year I received -.10 against July futures picked up on the farm with an end user.

How does that work?

The day the end user and I agreed on the -.10 basis, July futures were trading $9.26. So, this is the futures price the end user will be basing what to write the check for. Once the price is agreed on, the grain buyer and I exchanged futures in our respective accounts using our brokers at the CBOT.

• I give physical grain for cash to the grain buyer

• Grain buyer gives me futures for $9.26 + -.10 basis = $9.15 which is what the check is written for.

Following summarizes the details of these trades

• I sold November futures originally:       $11.47

• I bought them back on Oct 10:            $ 9.35

• Profit for this trade in my hedge account: $ 2.12

• I resold the futures against July on Oct 10 for the carry:                         $9.67

I bought the futures back through the exchange with the buyer of the grain:    $9.26

• Profit from futures price change:                                               $  .41

• Cash received from grain buyer (includes -.10 basis):    $9.16

• Profit from hedging trade:                              $2.12

Profit from Market Carry and hedge trade:              $.41

• Actual price collected for my grain:                     $11.69         

If I had just sold my soybeans for harvest delivery against $11.47 futures, basis was -.70 (meaning cash price would have been $10.77). By working the market carry and basis I received 92 cents more per bushel. It’s worth the little extra paperwork to me for 92 cents more per bushel.

 

That’s way too complicated

Many farmers say that when they see the details of the trading above. I completely understand. The first time I saw this process I was confused and didn’t think it was worth my time. But, after doing it the first time, I realized it’s actually really easy and very profitable for little increase in risk.

Nearly all the grain trading world does this type of trading with one exception….the farmer. Surveys indicate that as few as 5% of farmers are doing this type of hedging. Many farmers don’t realize that when they sell grain for a flat price (e.g. to your local grain elevator), they will use the farmer’s grain to do this type of trading to increase profits. That’s how they make money, taking the money farmers are leaving on the table. It’s done behind the scenes without telling you. In fact, most of the industry doesn’t want farmers to know about this type of trading, because it takes away from their profits. That’s part of the reason few people are talking about it. It’s one of the best kept secrets in agriculture.

Plus, it’s low risk. Historically market carry and basis premiums are available to the market, for those willing to do a little extra paperwork to take advantage of the profits. With corn and bean prices threatening to stay under $4 and $10 for another year, farmers need every edge they can to stay profitable.

 

Jon grew up raising corn and soybeans on a farm near Beatrice, NE.  Upon graduation from The University of Nebraska in Lincoln, he became a grain merchandiser and has been trading corn, soybeans and other grains for the last 18 years, building relationships with end-users in the process.  After successfully marketing his father’s grain and getting his MBA, 10 years ago he started helping farmer clients market their grain based upon his principals of farmer education, reducing risk, understanding storage potential and using basis strategy to maximize individual farm operation profits.  A big believer in farmer education of futures trading, Jon writes a weekly commentary to farmers interested in learning more and growing their farm operations.

 Trading of futures, options, swaps and other derivatives is risky and is not suitable for all persons.  All of these investment products are leveraged, and you can lose more than your initial deposit.  Each investment product is offered only to and from jurisdictions where solicitation and sale are lawful, and in accordance with applicable laws and regulations in such jurisdiction.  The information provided here should not be relied upon as a substitute for independent research before making your investment decisions.  Superior Feed Ingredients, LLC is merely providing this information for your general information and the information does not take into account any particular individual’s investment objectives, financial situation, or needs.  All investors should obtain advice based on their unique situation before making any investment decision.  The contents of this communication and any attachments are for informational purposes only and under no circumstances should they be construed as an offer to buy or sell, or a solicitation to buy or sell any future, option, swap or other derivative.  The sources for the information and any opinions in this communication are believed to be reliable, but Superior Feed Ingredients, LLC does not warrant or guarantee the accuracy of such information or opinions.  Superior Feed Ingredients, LLC and its principals and employees may take positions different from any positions described in this communication. Past results are not necessarily indicative of future results. He can be contacted at jon@superiorfeed.com.

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