Well, the grain harvest is over for the most part. The harvest itself was good in most areas with reports of good quality and good yields. The downside of the harvest was that cash prices for grain were down considerably from just a few short weeks earlier. Producers for the most part did forward some of their production ahead of time at very good levels. However, they were hesitant to forward contract very much, as last year was still fresh on their minds.
This year as well as last are great examples of why and how producers can market and hedge their production while at the same time be diversified in how they accomplish the end goal. In the past, we have visited about how nothing is perfect. A cash forward contract is good, but there is a trade-off, just the same as there is with hedging using futures and options.
I know that at times it sounds as though all I think about is hedging with futures, hedging with futures and hedging with futures. I will admit there are times when this is true; however, when it is all said and done, what I really want to encourage you to do is market your commodities.
Calling your local flour mill, grain elevator or exporter is definitely a part of marketing, but it shouldn’t be your entire plan. The same way that you get more than one opinion on producing your commodities, it is always good to get more than one opinion in your marketing process.
One question I am frequently asked is: What percentage should be forward contracted? At the expense of sounding like a politician, my answer is: That depends. Then I explain that the percentage is up to you and your comfort level. This is why it is always good to have a marketing plan (in writing) and then review it on a regular basis.
Let’s take a moment and look at a sample marketing plan where we break our production down into quarters. To start with, we are going to contract 25% of our production in the cash market. This will protect us from the prices trending lower. The downside of this contract is that we do need to deliver the commodity to the buyer, and if the market trends higher, we are locked into that price. Second, let’s hedge 25% using the futures market. This will also protect us from a market trending lower.
The upside to futures is that we won’t be required to deliver our commodities to a specific company. The downside is that it does require money. We will be required to have enough money to cover the initial margin as well as any additional margin requirements while we have the futures position. As with the cash contract, selling a futures contract will not let you participate in a higher-trending market.
The third arm of our marketing plan is hedging our price risk using options on the futures market. We will buy enough put options to cover another 25% of our production. The put option will protect us from the market trending lower while at the same time let us participate and sell our commodities at the higher price should the market trend higher. However, there is a premium involved in entering into this position.
The fourth arm is: We simply keep 25% of our production open (not contracted and not hedged).
Now when we look at this plan, we have three-fourths of our production protected against a market that is trending lower. At the same time, we also have half of our production that we will be able to contract at higher prices should the market move higher.
This is just a sample of a marketing plan that could work very well; however, it isn’t perfect and will require some work, study and education on your part. As we move into the fall months, now is a great time to begin working on your marketing plan for next year. Remember, your plan isn’t necessarily set in stone, but it will give you some guidelines to work with as we move forward into the next marketing year.
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