As harvest approaches, farmers will be deciding what to do with their corn crop. Most will likely store, yet there may be other ways to consider ownership. We’ll go through the pros and cons of four strategies, so you may begin your planning for postharvest decision-making.
With corn prices trying to find a contract low, the likelihood is strong that you’ll want to own corn in (what would likely be termed) the lower one-third or one-fourth of the market trading range for the year. Consider how much storage space you have, the cost of commercially storing, as well as risk of retaining ownership using paper tools.
Strategy 1 is keeping corn in storage.
This could be on-farm storage or commercial storage. In either case, the pro is that you have ownership. If prices appreciate, you can take advantage of this. Typically, prices reach their low sometime in the fall months, as supplies are most available to the marketplace. Prices then have a tendency to appreciate, as farmer selling slows after harvest and end-user buying increases. Another pro to storage is that you have control. You’re able to move your grain when and how you want to. The negatives, however, are that there is a cost to storage, whether it’s upfront or unseen.
These costs could be labor, rehandling, shrink, as well as interest and opportunity cost – that is, having your money work for you elsewhere. Your risk is market-price fluctuation. There is always a chance your corn could be worth less at a later date. The other risk is basis. Typically when prices rally, basis widens. That is, the cash market doesn’t keep pace with the futures market. Basis could also tighten, though typically this doesn’t occur in years like this, where ample inventory is expected from corn left over from last year’s crop and this year’s crop.
Strategy 2 is selling your corn and buying futures.
The pro is that this will allow you to generate cash flow and move your grain so you’re not handling it another time. There is a commission cost, as well as initial margin requirement. Typically, buying futures would suggest that you’re moving out a number of months for longer-term reownership. The negative with this, however, is that you could be buying carry in the market. In other words, the market has already priced in the cost of storage, so you’re already, in essence, paying for this. Nonetheless, the theory that a rising tide will lift all boats, when applied to the corn market, means that a rally in the corn market will mean a rally in all futures contracts equally.
Your risk isn’t fixed, which could be a problem if prices move downward. You may need to deposit margin funds in your hedge account to maintain what is termed the initial margin. Cash flow requirements are immediate if your account runs low, which can be emotional and may lead to poor decisions. Still, this is a viable alternative to storage. As prices move higher, you get the full strength of the change in futures. Basis risk is not a concern.
Strategy 3 is purchasing a call option.
The pro is that, if you sell grain and retain ownership through the use of a call option, you’re buying an instrument that allows you the right to own futures, and not the obligation. Your risk is fixed to the cost (premium) paid plus commission and fees. Typically, the advantage is that options allow you to stay in the market for a long time. You decide which month to purchase.
The more time you buy, the more cost you will incur. Often a call option will cost roughly the same as commercial storage. The negative is that you are likely to buy a call option that already has carry built into its price. Nonetheless, when owning a call option, you own a marketing tool with a fixed risk that allows you to retain ownership of a sold product. Not many industries provide this opportunity.
Our last strategy has a more aggressive tone, and that is purchasing a call option and, at the same time, selling a put option. This is known as a fence strategy.
The pro is that you’re selling someone else the right to go short futures at the designated put strike price, and you collect the premium. The idea is that by collecting the premium from the sold put, you’re anticipating prices will hold or move higher. The premium collected from the put is used to help offset the premium that you’re paying for purchasing a call.
This is a desirable strategy if prices trade range-bound or higher. Compare this to simply purchasing a call option where you may lose all premium, should futures remain range-bound. In the fence strategy, you may lose all of the premium on the bought call, yet also gain all the premium from the sold put. The disadvantage is that you are exposed to unlimited risk if prices should move lower. You have to be willing to accept a long futures position at the sold put option strike price.
The purpose of this perspective is to inform you of different methods to retain ownership of your corn beyond the storage capability. Storage is a great alternative that helps facilitate harvest, allowing you to move grain from field to bin. However, it may not be the best tool in all circumstances to retain ownership. Knowing the risk and potential of each of these strategies can help you make a decision when moving forward.
If you have questions or comments, contact Top Farmer at 1-800-TOPFARM, ext. 129.
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