Taming the Bulls & Bears

High Prices: Gift Horse or Trojan Horse?

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

Even the old timers have to admit they have never seen anything like this before in farming. We have skyrocketing commodity prices, even more than enough to offset the skyrocketing input prices.  If Mother Nature cooperates in 2008, our biggest concern might be tax planning. What a tough problem to have.

It is hard to believe that just two years ago I spent much of the winter trying to refinance loans, and find a way to minimize the losses from farming.  In January 2006, I gave a presentation to farmers titled “Can We Afford to Farm?”  The answer at the time was no. Fuel and fertilizer had already started their move up, but it would be several months until corn, soybean and wheat prices followed suit.  The outlook was horrible, cost cutting was the name of the game, and I was sick to my stomach not only for my own farm, but for the many farmers I work with. Two years later the farming economy has turned completely around.  I love my job this year.

My primary objective for 2008 is to continue to love my job. I love printing off a cash flow, and it works the first time; no shuffling acres, no refinancing debt, no postponing capital purchases. My biggest obstacle is the pangs of regret I feel from marketing the 2007 crop too early, and now it appears I have started marketing the 2008 crop too early as well.  I realize that most of you also have some pangs of regret, and I have found a solution.

The key to the 2008 crop marketing is put options. I know many of you have sworn you would never again purchase a put option and waste the quarter. The rest of you think put options are too confusing and you are not going to waste your time or money on some fancy schmancy scheme to make a broker rich.  All I ask is you finish reading this article before you start calling me names. 

For the 2008 crop year, we have a unique opportunity to lock in profits, and not just a buck or two, but I mean a 15 to 25 percent return on your investment.  Since our per acre investment in our crops is much higher in 2008, our loss potential is also much greater. We will either hit a home run, or sink like the Titanic.  A put option is the happy medium between the two extremes.

I look at durum growers who received twenty dollars per bushel this fall, and I get jealous. What if that happens to spring wheat, and my bins are empty?   Or what if I spend $700 per ton on anhydrous, and then sell the wheat for five bucks?  Let me say it again:  Put options are the happy medium between the two extremes.

I do recommend combining put options with your regular forward contracting. You do not sell all of your wheat on one day, and you should not purchase all of your put options on one day either.  Spread out your put option purchases, just like you spread out your wheat sales. If you raise 50 ,000 bushels of wheat each year, you may want to forward contract 25,000 and buy puts on 25,000.  The best part about put options is there is no delivery requirement.  You do not need to worry about your federal crop insurance guarantee, or your acreage changing if another commodity price suddenly skyrockets. The most you can ever lose is the premium you pay, and in 2008 we can lose a quarter per bushel and still make money farming.

One of the biggest hurdles to forwarding contracting the 2008 is the potential for acreage changes. Specialty crops such as sunflowers, canola, barley and edible beans, are all offering great contracts for 2008.  A little weather scare in South America could send soybean prices through the roof, and make that crop attractive. The battle for acres is still alive and well, so although prices are profitable, something might be more profitable this spring .  If you protect your profits with put options, you have more freedom to change your planting intentions.

Pencil out your cost of production, and if put options will allow you to lock in good profits with average yields, why not purchase the insurance policy?  Perhaps I am too skeptical, but I keep looking for ways that we are going to screw up the 2008 crop year. I am staring straight into the mouth of this gift horse, and looking for signs of trouble. I can use crop insurance to protect myself from Mother Nature, and the revenue insurance products provide some protection from falling prices, but not enough protection.  I truly believe that put options are the missing link for 2008 risk management.  If all goes well, spring wheat will follow durum to $20, and we will lose the quarter that was spent on put options. If the gift horse turns out to be a Trojan horse, we can still ride off into the sunset with profits in our pockets.