Identifying good brokers

Planting Progress

On our farm in SE Nebraska corn planting is complete and beans are underway. The balance of the central corn states are making progress on corn plantings and are likely on pace with the five-year average. While north of I-90 weather is limiting planting. This is still within normal range, but if cold and wet conditions continues to linger then upside potential in the market is possible.

 

Wheat

Some are suggesting that wheat may be damaged by cold temperatures, which may motivate farmers to put it up for hay, or tear it up and plant it to corn. Others say the cold weather may reduce test weight but increase protein levels. There is still a lot of wheat in storage from last year with low protein and heavy test weight, this could ultimately provide for great blending opportunities and limit any upside potential. Without a wheat rally it will be very difficult for corn futures to move significantly higher.

Lack of drought

For the first time in seven years the drought monitor shows no extreme drought conditions across the U.S. Once showers forecasted for the mid-south region move through, there will be few, if any, dry areas across the Corn Belt. In other words, weather conditions for the 2017 crop look nearly perfect to start, which is limiting price increases.

2016 option trades

As I will finish my 2016 options positions in late June, I compared the number of trades and profits I made this year to previous five. Interestingly, I made the most options trades in 2016; however, it’s worth noting that frequency of trading doesn’t correlate to increased profits.

Year

Options traded

Premium per Bu.

2016

38

$.25

2015

5

$.02

2014

5

$.01

2013

21

$.01

2012

17

$.08

2011

22

$.10

 

Why is there so much variance year to year?

Each marketing year is different and requires different strategy approaches. What works in one year, doesn’t always work in the next. This year the market stayed mostly sideways. Because of this, trades with shorter time periods and increased frequency were more profitable. While I never had more than 33% of my crop tied up in options throughout the year, I managed to collect 25 cents of trading options premium for all of my production bushels. I’m very happy with those results.

Understanding the impact of broker commissions

With so many options trades I mention above, it’s important to take into consideration broker fees when determining profitability. This is often dismissed by farmers as a small fee, but if not considered can make an impact on the bottom line.

Two weeks ago May corn was trading around $3.60. I had previously sold a May $3.75 corn call for 11 cents give or take. On a particular day two weeks ago the $3.75 May call was trading for 3/8 of a cent to buy it back. I did NOT buy it back for what seems like nearly nothing. A farmer questioned my reasoning on that day, saying that weather could send the market higher than $3.75 in a matter of days. While I understood his point, and I hoped he was right, I still didn’t buy it back. The reason — my broker and CBOT exchange fees along with the 3/8 of a cent to buy back the call would have totaled nearly 1 cent per bushel.

Seeing this individual trade outside of my marketing plan may seem shortsighted. Why wouldn’t someone do a sound trade that reduces risk exposure for 1 cent? The main reason: this trade only represents 10% of my 2016 crop production. I still have 85% of my 2017 crop production to sell and I need higher than current prices to be profitable. So, if the market swings above $3.75, and the worst decision I’ve made was to not buy back a call for 1 cent, I’m fine. When thinking about the big picture, I’m willing to sacrifice a loss on 10% of my crop when 85% of my next crop will benefit from that loss.

(The call in question above was part of a straddle trade, which also involved a sold put position. Generally speaking when doing straddles it is usually best to let the call expire worthless while a case could easily be made to repurchase the short put position for less than a penny because the nature of a short put position can make a farmer have to buy corn which adds risk.)

The total cost of commissions

Unfortunately, the market settled well under the strike price, so I made the right decision not to buy the call back. Often farmers don’t account for commissions in their marketing plan and don’t even realize what they are missing because individually they are usually small and seen as the “cost of doing business.” But, those commissions can really add up for farmers. For example, in the last year I’ve had 15 options expire worthless and eight that I let get exercised by choice (turning automatically into a futures position). If we assume each of those 23 trades were one contract each, I saved over $1,000 in commissions by not buying any of those options back. That $1,000 is a lot of money to pay for commissions on trades that are not likely even needed, despite the small reduction in perceived risk.

Conflicts of interest

Farmer’s also don’t always recognize the conflict of interest between brokers and their farmer clients. Generally, brokers make commissions based upon the number of trades executed. In other words, the more trades made, the more brokers make. To be clear, I’m not suggesting that most brokers intentionally make unethical decisions to increase their profits. For instance, in the example above it would be easy to justify buying back the $3.75 option two weeks before expiration because it would reduce my risk exposure. I’m just saying that farmers need to include the cost of doing a trade into their decision, and I doubt most brokers detail that out for them as to what and how fees are applied or why the farmer might not want to make the trade at all.

Broker fee structures

Fee structures vary from broker to broker. There is no set standard. Some charge the full “in and out” of an option upfront because they know some farmers will ride trades to expiration and not get out of them. Others charge more for options than futures (for the same reason). Unfortunately, I’ve also seen fee structures that were so strange and confusing that I would never consider working with a particular broker. I urge farmers to look carefully at their broker’s fees to make sure they are understood. Also, farmers should be wary of brokers who recommend excessive trades, suggest highly speculative trades, or do not fully explain not only the potential benefit of each trade, but also the potential concerns.

Identifying good brokers

Personally, I have a great relationship with my broker and have worked with him for 10 years. I feel confident he watches my back and advises me when there is a potential of wasting money on commissions. For example, when I need to make a trade and he identifies a way to avoid extra commissions, he lets me know. The best brokers understand that it’s more about having a long-term relationship than making a quick buck. If both the broker and the farmer are making money, it’s a win-win.

 

The expense of going alone

I’m also not saying that farmers should attempt to do options trading without the support of a reputable broker, even if that means slightly different or more expensive fee structures. Far from it. Trading options is very complicated and farmers would likely make more expensive mistakes going alone that would cost then more than the commissions of a broker. Sometimes you do get what you pay for. That being said, it’s important that farmers understand that brokers and farmers have different priorities and objectives. Brokers usually think like speculators and weigh each trade on its individual merits. I recommend that farmers aggregate all of their trades to an overall strategy, not just a few ideas. By doing that, most farmers would likely move from a strategy full of speculation to a less risky long-term strategy that will generally be more 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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