Plan to lock in higher wheat prices

When it comes to marketing a wheat crop, experts say it pays to have a plan in place and be ready to act when opportunities present themselves.

This is especially true in a price environment that is as volatile as wheat has been the past year (see chart below).

“A lot of guys just grow a crop and hold onto it,” points out Scott Doely, a wheat analyst with Benson Quinn Commodities, a subsidiary of ADM. “As a result, last year many people missed the boat on $5.00 cash wheat.”

Prices literally have been all over the board since last summer, and as of early March, futures were down more than $1.00 per bushel from recent highs. Still, new-crop spring wheat prices remain 70 cents more than this time a year ago, and they are at their highest levels at this time of year since 1998. In addition, weather-related rallies may create new pricing opportunities in the months ahead.

Charles Soule, Minneapolis Grain Exchange (MGEX) floor manager for Country Hedging, believes some pricing opportunities will arise in the coming months. “With the tight carryout (forecast by USDA), weather scares are inevitable,” he says. Soule predicts that futures prices for new-crop wheat, as measured by the September MGEX contract, have a good chance of getting back to the $3.80-$4.00 range.

To capture these prices, some sort of pre-harvest pricing program is a necessity.

Pricing ahead
History shows that as harvest nears, wheat prices tend to bottom. In fact, before 2002, new-crop spring wheat futures prices declined for six straight years between April and August.

Doely warns that a seasonal decline may well occur this year, as weak export demand could dampen any weather-related rallies and take prices lower by harvest. “I think if we see any rallies they will come early rather than later, and I don’t think we’ll see sharply higher prices by any means. A lot of the reason we’ve sold off recently is because of the export market. If we see exports continue to be cut, suddenly our tight stocks aren’t so tight any more.”

To protect against a seasonal decline in prices, more often than not it pays to price at least a portion of a crop ahead of time.

One way to lock in a price is through the use of spring wheat options, traded at the MGEX. Options can be used in a variety of pricing scenarios to provide added flexibility in a marketing plan.

Buy a put
This simple strategy establishes a price for a crop with limited risk and without eliminating upside potential. A put option increases in value when futures prices decline, offsetting the lower cash price received after harvest.

However, should prices rally dramatically as they did in 2002, a producer can still participate in the upward price move. That’s because the risk in buying a put option is limited to the amount of premium paid.

Cash forward contract/utilize call options
If a producer prefers to use cash forward contracts to price a crop, it may still make sense to use a strategy that allows you to participate in dramatic rallies like those seen in 2002 and 1995. The strategy may be as simple as buying an at-the-money call, which will appreciate in value as futures prices rise.

Another strategy is to use a “call spread” to reduce the amount of premium paid for the call option. In this strategy, a producer forward contracts his wheat, but then uses a call spread to remain in the market should prices rise. The spread consists of buying an at-the-money call, while selling an out-of-the-money call.

For example, a producer might buy an at-the-money $3.70 call and sell an out-of-the-money $4.10 call. The premium collected for the $4.10 call offsets the premium paid for the $3.70 call. Now, if prices rally, the producer will have the opportunity to realize gains between $3.70 and $4.10. Once the price rises above $4.10, however, the loss in the $4.10 call will begin to offset gains in the $3.70 call.

How much to sell?
The amount of a crop that’s marketed before harvest is always a tough call. One straightforward way to determine how much to price is by using crop insurance.

With crop insurance, a producer is guaranteed a certain number of bushels. By knowing this number, crop insurance can be a valuable tool in a marketing strategy in that it allows producers to price up to that guaranteed amount.

Getting started
For more information on using options in a marketing strategy, www.MGEX.com, the Minneapolis Grain Exchange website, is an extremely valuable tool. This site contains resources for beginning and experienced traders, including information on trading futures and options, currentfutures and options prices and historical data.

2002 Not the Norm

Last year’s dramatic summer rally was impressive but also unusual. In fact, it marked the first time since 1995 that spring wheat futures prices rallied between April and August. This table illustrates how the market has fared since 1995. The prices listed here are MGEX September closing futures prices on April 15 and August 30.

Year	Sept futures on April 15	Sept futureson August 30	Change in price
2002	$3.12 ½	$4.33	+$1.20 ½
2001	3.47	3.14 ½	-  0.32 ½
2000	3.41	3.03 ½	-  0.37 ½
1999	3.43 ½	3.25	-  0.18 ½
1998	3.74 ½	3.16	-  0.58 ½
1997	4.40	4.22	-  0.18
1996	5.41	4.64	-  0.77
1995	3.58 ½	4.48 ¾	+ 0.90 ¼

Before 2002, prices followed a seasonal tendency to steadily decline as spring wheat harvest neared. This pattern was unbroken for six years, and declines ranged from 18 cents per bushel to 77 cents. Buying a put option or selling futures can help protect against a seasonal price decline.

Prices did rally in 1995 and 2002, and, in fact, they rallied dramatically. If a producer prefers cash forward contracting, it may be beneficial to use a call option strategy to capture gains should 2003 go the direction of 2002.