Betsy’s Bulls and Bears

Are You Prepared For “The Big One?”

By Betsy Jensen
Ag Commodity Instructor, Northland Community and Technical College, betsy.jensen@northlandcollege.edu

Every day I hear more and more talk that “The Big One” is just around the corner; the mother of all rallies, the rally to end all rallies, glory days of $6 wheat, $5 corn and $15 beans, and that those who hold their grain will be well rewarded.

I agree that the markets are primed for a big rally, but then again, we’ve been hearing about that for several years now. There have been some pretty good rallies, including the 2002 wheat crop had a big rally, but then dropped from over $5 futures to $3.50 futures in less than nine months.  Soybeans have rallied lately, but can they rally even more?

Will we see “The Big One” in 2004? If we do, we should assume that it won’t last long. Just look back eight years (has it been that long already?) to 1996, the last time the stars aligned for big market rallies.

I argue that we cannot market our grain on the hopes of a big rally. Do you crawl into your bomb shelter every time the government raises the security warning from periwinkle to mauve?  Are you still eating canned goods left over from the Y2K problem? If the answer is no, then why would you hold grain on the hopes for a big rally?

With tightening world stocks in corn and wheat, and tightening U.S. soybean stocks, it does increase the possibility of a big rally, but there are better ways to take advantage of it than by hoarding grain.  The first key to taking advantage of a big rally is by using options.

I know many farmers who have thrown options out of their marketing plans because they usually expire worthless, and you’re just throwing away $0 .20/bu each time you buy one.  I have to admit most of that is true, but what if we can use options to lock in a profitable price? 

In the fall of 2002, I purchased a put option that locked my floor at $4.45 Minneapolis futures. I had to hold my cash grain for seed sales, but futures hit $5, and I just couldn’t sit by and do nothing. The bad news is that I locked in a floor of only $4.45, even though the futures market was $5.  The goods news is that there is no such thing as “only $4.45” wheat. In most years, $4.45 wheat futures would be reason to celebrate, and I had to keep that in mind even though the futures market was over $0.50 higher.

Look at doing the same thing during the big rally. Put options are going to be incredibly expensive, but you have to keep telling yourself “I’m locking in a profit, I’m locking in a profit.”  No farmer has ever gone bankrupt doing that. 

On the opposite side, just imagine wheat futures are $5 at harvest, and of course you’re still bullish, but common sense (and your banker) is telling you to sell your grain.  By the time you take away basis and your call option premium, you can probably still walk away with $4.50 cash in your pocket, plus the chance to make more money if wheat continues to rally. 

In anticipation of “The Big One,” I’m going to ask you to set two goals. The first goal will be your floor price. Tell yourself, your banker, your spouse, anyone who will listen “I will buy put options on 100% of my production if I can lock in a floor price of (fill in futures price)”. If you said a floor price of $4.50 wheat, that might mean a $4.70 put for $0.20, or a $4.90 put for $0.40.  Any combination of strike price minus premium that will net you a futures price of $4.50. 

The other goal to set is your lightning strike price, which we discussed last month. “May lightning strike me dead if I hold any cash wheat above (fill in cash price).” If wheat rallies to that price, you sell everything and reown with a call option if you are still bullish.   Make sure to use a “Good ‘Til Canceled” order with your elevator to make sure everything gets sold at your price. Your elevator manager might think you’re crazy for placing an order to sell wheat at $5.50, but maybe you’ll have the last laugh.

When using options, there are two distinct strategies. The first strategy is “hold cash, buy put.”  Use this strategy in pre-harvest, when you are unsure of production, or anytime when you can’t or won’t sell cash grain.  If protein discounts are steep, or if the local basis is weak, you may be better off locking the bin doors, but protecting your price risk with a put option.

The second strategy is “sell cash, buy call”.  Use this strategy when it’s beneficial to sell cash grain, but that little bull sitting on your shoulder won’t stop whispering about how high prices are going. It’s easier to sell cash grain when you know you can still make money if prices rally. 

We shouldn’t be afraid of rallies in the commodity markets, but yet farmers often end up paralyzed like deer in the headlights, not knowing what to do.  Options take the stress and risk away from the farm, and allow us to sleep at night, knowing that we’ve got a strategy in place that will help us make money if and when “The Big One” occurs.

Jensen farms with her husband Brian near Stephen, Minn.  Her market education activities including this column are supported in part by the Minnesota wheat checkoff, directed by the Minnesota Wheat Research and Promotion Council. If you have a question or topic related to marketing that you’d like to see addressed in this feature, call 1-800-242 -6118, or email Jensen: betsy.jensen@northlandcollege.edu .