Should my hedge account show a profit or loss at the end of the year?

As harvest finishes with record yields across the Midwest, corn prices fell below $3.40. However for the week it was nearly unchanged. Many farmers have struggled to sell at profitable levels, and while higher than average yields help offset lower prices some, it hasn’t been enough. Also contributing to lower prices, funds continue to hold large short positions with little incentive to adjust.

Beans also had average or above average yields throughout the Midwest, but beans have been high all year long in relation to corn prices, which has allowed for profitable levels for most farmers. This has eased the sting of low corn prices for many farmers. Looking forward, South American weather forecasts have been favorable, but we are nearing the part of the growing year in which every new forecast can drastically change the market direction.

 

Basis

Basis values are increasing throughout the Midwest for both corn and beans. This means farmers aren’t selling and end users are looking for some coverage as the locks go on the grain bins. Also spreads between futures contract months have narrowed slightly, which sometimes can mean we’ve hit a bottom.

 

Looking forward

2018 may be a unique marketing year as farmers sell beans earlier and corn later, waiting for a rally. Some in the trade may be surprised how long farmers will hold out on the corn in an effort to get higher prices. While I’m not overly bullish corn, I think a 10- to 20-cent increase in the short-term could be reasonable.

 

Should my hedge account show a profit or loss at the end of the year?

Farmers are often disappointed if their hedge account doesn’t show a profit at the end of the year. Others assume that they will always lose money in their hedge account. I tell farmers that profits or losses at the end of the CALENDAR year don’t matter. What I find to be the most import thing is if my grain’s FINAL CASH VALUE + HEDGE GAIN or LOSS is above profitable levels.

 

Example 1

A farmer sells corn for $4 futures and a zero basis level

Raises 100,000 bushels

Loss in hedge account = – $20,000

Net value of corn: $3.80

(Math: -$20,000 / 100,000 bu. = -.20 + $4.00 = $3.80 net cash value)

 

Example 2

Farmer sells corn for $3.80 futures and a zero basis level

Raises 100,000 bushels

Profit in hedge account = $10,000

Net value of corn: $3.90

(Math: $10,000 / 100,000 = .10 + $3.80 = $3.90 net cash value)

 

Example 3

Farmer sells corn for $3.60 futures and a zero basis level

Raises 100,000 bushels

Profit in hedge account = $40,000

Net value of corn: $4.00

(Math: $40,000 / 100,000 = .40 + $3.60 = $4.00 net cash value)

When farmers don’t combine their cash grain price with their hedge account’s profit or loss they don’t fully understand their farm operation’s actual profit or loss. It doesn’t always mean that low prices on the check from the elevator are bad. A low cash value with big hedge profit can turn out to be the best thing.

That’s why I ALWAYS understand all possible outcomes of each trade when I place them. I want to know what my potential net position (i.e. my real profit price) in advance. If I make money in my hedge account, but don’t sell any grain I have no guarantee that I’m going to be profitable. If I lose money in my hedge and sell grain at unprofitable prices, then I could be in an even worse situation than doing nothing.

Only by understanding all possible scenarios for each trade and how that will affect my final cash value can I really market my grain effectively and efficiently for my farm operation. A true hedger doesn’t care if they make money in their hedge account or on the cash sale of the grain. A true hedger only cares what their net priced received for all of their grain was for the year including the profit or loss from their hedge account.

 

Sold another straddle

Again, I expect a sideways market for the next two months. Since prices are unprofitable, I want to “manufacture” some premium in the market while still maintaining low overall risk. Therefore, on 11/16/17 when March corn was $3.49, I made the following trade on 10% of my ’17 production.

  • Sold – February $3.55 straddle, where I sell both the $3.55 put and $3.55 call and collect just over a 17-cent premium
  • Trade expires 1/26/18
  • Potential benefit — If March futures close at $3.55 on 1/26/18, I keep all of the 17 cent premium
  • Potential Concern — Reduced or no premium if the market moves significantly in either direction. For every penny lower than $3.55 I get less premium until $3.38. At $3.38 or lower and I will be losing money on this trade penny for penny. For every penny higher than $3.55 I get less premium until $3.72. At $3.72 or higher I have to make a corn sale at $3.55 against March futures, but I still get to keep the 17 cents so it’s like selling $3.72

The biggest risk in this trade is if corn is below $3.38 at the end of January because I’ll lose money on this trade. If this happens, I can buy the straddle back and take a loss, or remove a previous sale I have made, and take any profits on the difference between what I sold in the past on another trade and $3.38, against the March futures. Then I can wait for a future rally and sell again, adding that premium to another sale. While I hope this doesn’t happen, and I think there is a low chance it will, I still ALWAYS understand the worst case scenario for all of my trades and I am willing to accept them. It is also why I limited the amount of bushels I placed in this trade to 10% of my ’17 production.

 

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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