A lesson in “risk off hedging”

Weather forecasts are favorable for planting the next two weeks, so the market is expecting the 2017 corn will be planted easily. This news combined with positive long-term forecasts means the market is pulling back some, suggesting the possibility of another record corn crop.

Funds reduced their length in bean futures and increased shorts in corn and wheat. If the weather forecasts change, funds may change positions providing upside potential. With 75 days left in the corn weather market, I will be surprised if there isn’t at least one weather scare before July.


Market action

Two weeks ago I moved some of my ’17 beans from Nov futures back to Aug futures. I thought there was a strong chance I could catch the inverse, then have it turn back to a profitable carry eventually. The market is shifting to what I expected would happen. Therefore, I’m moving another 20% of my ’17 crop with a similar trade. Of course, now the premium is lower. The roll back was only 3 cents this week, when it was 15 cents two weeks ago.

Basically, now at most I can make 25 cents on this trade with downside risk of 35 to 40 cents. Two weeks ago the profit potential was 30 cents with a downside closer to 20 cents. Knowing this I bought a calendar spread option (CSO).


What does this mean?

In this case, I bought the Jul/Nov Even (or 0) CSO for 7.5 cents (note, the even spread is the strike price of the option). Essentially, I think that the spread between the Jul and Nov bean futures (on Jun 23) will be the same or Nov will be higher (a carry).

  • If this happens, I can roll my Nov futures back to July, then roll it forward to Aug, then Sep, then Nov taking a carry worth potentially 25 cents.
  • If it doesn’t happen, the spread becomes a much wider inverse, then I don’t make the futures shift and I’m only out 7.5 cents.

In other words, I’m risking 7.5 cents to try and make 25 cents.


Why did I do this?

Like all farmers I want bean prices to go higher, but for a significant increase in futures it will require a surprise supply disruption before July. This seems very unlikely given current conditions in South America. If prices stay the same or go lower with heavy global supply, the market will have to pay someone to store the beans (i.e. a carry) until they are needed. It could be a consolation prize if the market continue their downward or even a sideways trend in soybeans.

Per my usual marketing strategy, this isn’t a “home run” type of trade. It’s a potential base hit. But with what I know today, I think there is very good chance beans will move from an inverse to a carry and I’m willing to risk losing 7.5 cents to make 25 cents on this highly reasonable outcome.


Lifting hedges

Recently a farmer asked me if I like to “lift hedges” if the market moves lower and has the possibility of bottoming out. The short and simple answer is no, I don’t lift hedges. “Lifting hedges” is code for speculating. I don’t want to be a speculator with my marketing program. I have hedges in place so I know exactly where my grain is marketed. Additionally, my banker is completely on board with my program, and the last thing they want me doing is speculating. My banker trusts I am doing sound marketing that minimizes risk. I never want to violate that trust.


How big of a hedging line do I need?

A new client was surprised to find they received a hedge line with their bank that was bigger than their operating loan. While the farmer may never need more than 25% of the hedge line, the rest is available should a large margin call be needed. The bigger surprise to my new client: the banker was completely supportive of the large hedging line. This banker understood “risk off hedging” and what was needed to make it successful.

It helped the banker had followed my marketing strategy for many years and felt comfortable with their clients taking advantage of opportunity. However, I find most bankers understand hedging and prefer clients use proper hedging techniques versus speculating. I always speak with new clients’ bankers before starting a marketing program so I can verify the client and their banker are on the same page. I never want surprises down the road when margin calls accumulate. As a hedger I don’t fear margin calls, and neither does my banker.


Why are few farmers doing “risk off hedging”?

Speaking with bankers, few farmers are taking advantage of this kind of marketing strategy. “Risk off hedging” isn’t sexy or exciting. It’s boring and safe, which unfortunately is not something most people like to participate in. However, boring and safe helps me sleep at night and understand/realize future farm operation profits.

Be cautious of advice that suggests lifting hedges. It might turn out to be great advice, but remember you have another crop coming in less than a year that will need to be marketed. Adding more pressure to sell additional bushels in an uncertain market puts farmers in a risky position. What if the market really hasn’t bottomed out yet?

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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