How Hedging can help when margins are tight, and considerations for getting started
As we look ahead to the 2016 growing season, margins are generally looking like they may be tight for most Prairie crops. There are some exceptions as current new crop offers for a number of pulse and specialty crops look pretty attractive. However, most cereals and oilseeds are currently penciling out mediocre returns if one assumes average yields. This will vary by farm, region and crop, but the current fundamental backdrop doesn’t point to any home runs on the horizon without significant weather problems in key growing regions this coming summer.
In these lackluster price environments, growers need to make the best of the opportunities that the market will periodically offer. One way to help manage risk and increase marketing choices is through hedging with futures and options. When used correctly, these tools can allow growers to:
- Secure a minimum price while not taking on any production risk.
- Lock in a futures price and wait out weak basis levels while still having the ability to shop around your physical grain to the buyer that wants it most.
- Maintain some exposure to upside in the market even after selling cash grain.
These tools can also be extremely flexible when one looks at the multitude of different futures months, strike prices for both puts and calls, and ways to piece the various contracts together.
There are a couple of things that farmers need to keep in mind if considering using futures and options.
First, it’s critical that growers make sure they take some time to understand the basics of how these tools work. The vast majority of ‘bad experiences’ that farmers have had with futures and options can be attributed to either not understanding what they were doing, or else crossing that line to where they are speculating on the market instead of trying to manage risk on their operation. This investment in the basic knowledge of how hedging works needn’t take long, and will help growers better understand the various pricing programs that are offered by other grain buyers.
Second, it is important that growers use a futures broker that specifically works with farmers and understands what they are trying to accomplish. This includes taking the time to learn about your operation’s goals and risk management needs, and also doing some of the necessary ‘hand holding’ that is required when hedging for the first time. A good broker will help ensure that any positions you put on actually reflect what you are trying to achieve, and help ‘keep you out of trouble’ along the way.
In a world where tight margins appear to be the new normal, farmers need to take advantage of every tool they can to more effectively manage risk and make the most of opportunities that the market periodically presents. There is no ‘magic bullet’ – instead this requires using a range of strategies. Futures and options can be one effective tool within the broader mix.