Don’t give away your risk premiums with specialty crops

Last week many speculated as many as 2 million wheat acres were damaged after cold weather struck much of the Midwest. While this caused a nice wheat futures rally Monday, it was short-lived because this represents only about 100 million bushels, or 10% of forecasted total wheat carryout. This is likely not a big enough issue to change prices long-term.

Even with the cold weather and threats of replant, corn prices can’t build any momentum. With 2.3 billion bushels of carryout and farmers sitting on too much unpriced stored corn, traders are starting to realize a production issue is necessary for any substantial rally. For the week, corn was up only about a nickel and for the past four months the range has been less than 30 cents.

Despite being frustrated with current prices, I have plans and orders in place if there is a quick price surge and a profitable opportunity presents itself. It’s more important than ever for farmers to be ready by knowing their breakeven points, necessary profit levels and having orders in place. Those that plan ahead will be rewarded.

 

Market action

After the success of recent straddles trades, I did another similar trade.

 

Trade details: sold August $3.70 straddle for 35 cents (I sold the $3.70 put and the $3.70 call and collected a total of 35 cents)

  • Trade expiration – 7/21/17 – after the weather markets for the corn crop is known
  • Percent of 2017 production — 5% (This trade takes place after 7/4, so it’s a new crop trade for me)
  • Expected market direction for late July — Assuming normal weather the market should trend lower
  • Potential benefit — If Sep futures close at $3.70 on 7/21, I keep the 35-cent premium
  • Potential concern — Reduced or no premium if the market moves significantly in either direction. For every penny lower than $3.70 I get less premium until $3.35. At $3.35 or lower, a new crop corn sale is removed, but any profits gained on that trade can be added to a future sale. For every penny higher than $4.05 I get less premium until $4.05. At $4.05 or higher I have to make another corn sale at $4.05 against Sep futures. A Sep trade can then be “rolled” from the Sep to the Dec and I will like pick up 10 cents of premium and this trade would be about $4.15 against the Dec.

This trade is most profitable if the market continues to trade sideways. While this type of trade has been profitable recently, it important to not be complacent and be aware of risk, therefore its only 5% of my production (my previous straddle trades have represented 10% of production). Still, I think this trade has potential. I already have 15% of my ’17 crop hedged around $4. Worst case scenario, I will have removed 5% of sales while taking home a 65-cent profit between the straddle and previous sale that can be added to a later sale.

 

Don’t give away your risk premiums with specialty crops

Growing specialty corn (i.e. seed, white, non-GMO, high oil, silage, etc.) is getting more popular with farmers due to the premium associated to any corn that isn’t used for feed stock or ethanol. Often proximity to a specialty corn buyer is the main reason for the premium, but sometimes it can be yield-potential reduction or just a matter of trying to keep all of the crop identity preserved.

The risk for these specialty crops comes in the form of cross-pollination to insects or increased weed treatment. Specialty crops are “special” because they are hard to replace if there is a production issue at a local level. Plus, most farmers don’t want the hassle, or risk, of raising these crops. That’s why there are heavy premiums. If everyone was doing it, there wouldn’t be the premiums.

There is definitely opportunity to make a good profit raising specialty corn, but I notice many farmers making marketing decisions that potentially leave money on the table. Let me explain.

Typical farmers usually price their specialty crop first. They see a flat price with let’s say a 40-cent premium more than traditional corn. They get excited about the high price, and lock in early. Usually they price it during the winter months when traditional yellow corn prices looked suppressed.

I recommend:

  1. Determine what premium a farmer receives for raising the specialty crop (40 cents maybe?)
  2. Back that number off and find the futures value.
  3. Add the standard basis price for regular yellow corn, and determine if you want to price any yellow corn at that level.

Usually when I’ve walked farmers through this exercise they say they wouldn’t price yellow corn at that level because they think prices will go higher.

When outlining a marketing strategy, I recommend that farmers pool their specialty and regular bushels together. If a futures level meets the farmer’s criteria to sell based upon profitability goals, then they should sell at that futures level. In doing this, they have the flexibility to apply a sale to any of their crops later. This can be advantageous if there is a chance they aren’t able to meet the necessary supply of the contract for yellow or even the specialty corn. All future sales should work toward an average sum. Farmers can always apply specialty crop premium later.

In other words, by doing this recommended approach above farmers are basically setting their basis on specialty crops early while setting futures prices later. This provides farmers with more flexibility and premium/profit potential on all their corn. A good rule of thumb: if a farmer wouldn’t set their yellow corn prices now based upon futures prices, then they shouldn’t be selling their specialty crop either. Raising specialty crops can be risky, don’t give away the premium for taking on that risk because you like a certain cash price.

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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