Hedging grain using futures in a hedge account versus HTAs

By Jon Scheve, Superior Feed Ingredients, LLC
I am often asked why I hedge my grain using a futures account instead of using HTA (Hedge To Arrive) contracts with an end user. The following are some of the pros and cons.   
Setting up a futures hedging account This is a one time “hoop” hedgers using futures must do that selling an HTA does not require. Including a hedge line with a bank to finance the hedge account is also a good idea.

Cost to finance a hedge account v. HTA fees
To compare HTA fees to the costs associated with selling through a hedge account, let’s assume you are holding your grain from now until October, or for 4 months. While HTA fees can vary, for a 4-month time period the cost would probably average around 4 cents per bushel based upon conversations I have had with farmers who have been using them. Selling a futures contract in a hedge account has several costs:
• Initial margin maintenance This is the amount I am required to have in my hedge account to sell a grain contract. Note, I get this money back when I set my basis and establish a cash price with an end user and exit my hedge position sometime in the future. This cost is set by the CME group. It fluctuates with the value of the commodity, and it seems to run around 8% of the value of the underlying commodity. It has been running around $1,300 per corn futures contract recently. I usually budget $2,000 per contract. This is equivalent to 40 cents per bushel on a 5,000-bushel contract ($2,000 / 5,000 bushels in a contract = 40 cents per bushel). Since I get all this money back when I exit the position, I only need to factor in the cost to borrow this money from my bank for the duration I hold the position. Assuming a $2,000 initial margin cost, at a 9% interest rate, it costs me 0.3 cents per month to maintain a contract in my account (40 cents x 9% / 12 months). So, if I deliver my grain in October after 4 months, it will cost 1.2 cents per bushel in interest on the initial margin portion.
•Broker commissions To sell a contract and buy it back averages around 1 cent per bushel with a broker.
• Margin call — Maybe This is money I may need to move into my hedge account if the market rallies above my short/sold position. Basically, I will owe “penny for penny” the difference in my hedge account. Large margin calls don’t happen all the time, but if one does occur, much like the initial margin maintenance above, I will be able to offset all the margin call money when I sell the grain for cash and buy back my short/sold position. It is challenging to plan for margin calls, because no one knows how high prices will go. Therefore, I usually budget for a realistic 50-cent weather rally before harvest, while also knowing a $1 rally is possible during the summer.  Like initial margin maintenance, the actual cost would only be the interest from my bank on the hedge line loan for the margin call. Assuming a 50-cent margin call at 9% interest/12 months, the monthly cost would be 0.4 cents.  If a big margin call happens, it will probably only last a short time. So, over the 4 months from now until October, a 50-cent rally at some point during that time would likely only cost 0 to 3 cents total, depending on the duration of the rally. For example, 4 months of a 50-cent margin call x .4 cost on interest per month = 1.6 cents. Contrary to what most farmers think, margin calls are just fine and a part of doing business. They indicate that prices rallied. The bigger the margin call, the bigger the rally.  To recap, following is the cost to have my grain hedged in my hedge account until October: Initial Margin Maintenance: 1.2 cents Commissions: 1 cent Margin Call – Maybe: 0-3 cents Total Cost: 2.2 – 5 cents Basically, the cost to use a hedge account is very similar to selling with an HTA.  

Flexibility — Not locked into any end user
The two main reasons why I do not like HTAs: I don’t want to be locked into using one end user.I don’t want end users to know my positions in the market. I never know which end user will have the best bid in the future. If I use an HTA contract, my grain is locked with that end user, and I am totally dependent on the basis value that grain buyer decides to post. I have lost all my negotiation power, and my hands are tied, which could easily mean 10 cents per bushel of missed opportunity, and in some years even more.   But my local merchant lets me take my HTA grain wherever I want… Some grain buyers have this option, but these types of HTA contracts tend to have higher fees. Plus, if the grain is not taken to one of their select locations, there can be additional fees. Personally, I would think that if an HTA contract has low or zero fees AND complete flexibility in marketing the grain, how is that buyer making money? Their costs to run an HTA is likely similar to my cost to run a hedge account. So, why would a buyer be giving something away for free?   

Flexibility — Move sales between months
I also want the flexibility to move futures sales between months at any time. For instance, I may initially roll my hedges and plan to deliver my grain against the July contract. However, what if there is a problem with the quality of my stored grain and I need to move my corn earlier? Perhaps snow blew into my bin in late spring and my grain is getting hot, so I need to move it.  With a hedge account, I can easily do that and only worry about the spreads between contract months and brokerage commissions. Some HTA buyers have penalties to change contracts to an earlier date, on top of those same spread differences. Some HTA buyers only allow a seller to roll the contracts one time. I don’t want to be forced to play by someone else’s rules.  

HTAs may be unavailable
In the past, during fast moving markets, some buyers have limited the use of HTAs. For instance, in summer 2012 some grain companies stopped offering HTA contracts for several days, which put some farmers in a bind. Those with futures accounts could still sell their grain whenever they wanted.  

I want to have full control of my grain sales. The minor cost to carry my own hedge account is almost always offset with better basis values and improved negotiating power. If I make just 3 cents more than my expenses to carry my own hedge on 100,000 bushels versus the holder of an HTA contract, that means an extra $3,000 in my pocket. If I can make 10-cents more, which happens more often than HTA contract holders realize, that is a lot of money to add to my bottom line. I encourage farmers to consider all the benefits of using their own hedge, and trade grain like most buyers do. Almost no major grain buyers to my knowledge are using HTAs to hedge their own grain. They are most likely using hedge accounts and futures as I describe above. If you would like to learn more about how I use futures to hedge my grain instead of using HTA contracts, reach out to me.

Please email jon@superiorfeed.com with any questions or to learn more. Jon grew up raising corn and soybeans on a farm near Beatrice, Neb. 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.

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