CFGAG News and Views vol. 13     August 1, 2010

"There is a risk of loss when trading futures and options. The thoughts and opinions expressed in this article are those of the author, and while believed to be correct, are not guaranteed as to the accuracy or content. Past performance is not indicative of future results, and each individual should examine their own risk capital carefully before trading."
July turns HOT!
There is nothing like volatile markets to get the  temperature up, and compared to last year, 180 degree turnaround. On June 30, the USDA numbers showed we did not plant as many corn acres as the trade believed, so off we go, and throw in some hot weather forcasts, and the stage was set for a good rally. These are the weather markets we talk about so often, and they usually dont last very long. As soon as the first storm system lights up the radar, down we go. As we have said so often, emotion usually gives us an opportunity to make sales at good prices, but one has to be ready and have the orders in, along with a plan to manage risk from that point on. 
One of the things we try to do in our business is find ways to hedge grain at profitable prices and yet remain flexible to take advantage of market movement to add to profits. An example of this is the recent opportunity to get a $4.00 floor price in Dec. futures, but "keep the window up open" to $4.50. The week of July 12-16 gave us that opportunity. We were able to buy Sep 3.90 puts and sell Dec 4.50 calls for even money. The spread in futures between Sep and Dec is approximately 12 1/2 cents, so even with transaction costs, we should be really close to $4.00 Dec. futures. Now that we have this on, I want to examine closely all our choices to make plans for what each individual wants to do.
The basic philosophy behind this position is simple. We know the high in Dec corn all winter was 4.50. Its going to take some really bullish developments to take that out, and everyone seems willing to sell this years crop there. So, we sell option premium, (time value) to pay for time value (Sep 3.90 puts) that establishes our floor. We arrive at the approximate $4.00 floor in December futures by adding the spread value between September and December futures, which is 12 1/2 cents at this writing. If the market falls, this spread should widen further, actually making the floor price higher. We dont know this will happen, but watching the spread difference between those months will give you the exact numbers to use in figuring the floor price. Transaction costs should also be subtracted, and those will vary with the types of actions taken. Call us for these details as they pertain to your position.
After putting these positions on, the market sold off quite rapidly. It looked like we hit the weather market perfectly, and a test of the June lows was inevitable. Then along comes the wheat rally based on drought in Russia, and huge fund buying of all grains. What we have now is a technically based rally, with fund postions now very long. No one knows where the buying will end, we now have analysts talking like we could be repeating 2009-2008. It should be noted that some of these same analysts were preaching doom and gloom just a few weeks ago. Has anyting really changed? Yes, a lot of specualtive money has come back into the market, at a time when we would not expect it. Harvest is fast approaching, and plenty of grain will soon be available, along with ample old crop stocks. World wheat supplies are significantly higher than 3 years ago, but fear and emotion are now back in play in wheat. So what to do?
Keep focused on net farm income. This rally has added a lot of profit to our farms, both for this year and for next. $10.00 beans and $4.00 corn are available again, when 5 weeks ago, we were more worried about 8.00 and 3.00. Our option position is working, and we need to make some choices as to its management. If the market tops out here (4.05- 4.10 December) and falls back toward the June lows, our first move is to exit the short Dec. 4.50 calls. If one is bearish, and wants to hold to expiration, margin money will be tied up until November 26th. For my money, anything around 3 cents is a good time to remove that side, as interest and opportunity out weigh the 3 cents I could gain, but each individual needs to make that decision based on their own situation.
The next side is the Sep put. Here is where we go back to our basic marketing plans, and look at each producers needs. The option expires on Aug 27. If the market has sold off, lets say to 3.50 Dec for example and we have roughly 50 cents profit, here are our choices:
1) Exercise the put into short Sep futures at $3.90
2) Roll the put down by moving to an at the money (3.50) December put
3) Exit the position, take the profit, and hold corn for higher prices
4) Exit the position, sell cash corn, add the profit to the cash sale and call it a day.
If we choose 1 above, we can now roll the futures position to December or any other month depending on the spread (carry) in the market. If you have storage, and want to hold for maximum carry, you can stay hedged throughout the year and collect this, only selling the cash grain when the basis is most favorable. The basis will be highly variable depending on demand for cash grain, yields and storage in your area, the outlook for next years crop, etc. If you do not have storage, you can choose #2 above, sell the cash corn, and then buy futures against the put. This is a low risk reownership play, where the total risk is the value of the put you are buying against. Remember, you have already added to your sales price with the amount of the difference between the Sep 390 put and the Dec 3.50 put. Actual amounts will vary depending on the time value left, and also where the futures price actually is. We can only estimate this value, but having some targets in mind always help make those decisions easier. Again, by the third week in August, we should have a better handle on yields, compare that production to storage capacity, weigh the costs of storage verses the basis, consider cash flow needs, and then tweek our plan to maximize our profits.
So what if the market rallies from here?  Actually, for net farm income, this is a good thing, but we will hear from folks worried about margin calls and losing money on the short call. Unless you have sold all your cash grain, it is going up in value much faster than the value of the call option, which loses time value every day. If the market does rally sharply for any reason, we have choices here as well:
1) Sell cash grain and exit position.
2) Fund the margin on short call and roll puts up
3) Buy a cheaper Sep call to neutralize the short Dec call (less time value to pay for)
4) Buy back short call
Remember the most important rule not let emotion drive decisions. Work with your banker and broker to analyze the net effect to total farm income. When considering this, add your crop insurance agent as well. If the market does sell off and make new lows, you could have an insurance payment coming if prices stay low or you have been affected by adverse weather.  You can protect that payment by being long futures at some point, because downside is protected by insurance, and the only way to lose net income is the market rallies. Talk to your agent and to us to see if your numbers would justify this type of action. 
Keep in mind that every farm and every individual has different wants and needs. We try to keep that foremost in mind when working with you, and do not advocate doing something just because "everyone else is doing it". Very often I find that a producers "gut instinct" is right on, and therefore needs to be respected. We just want to provide you with ideas and choices, you choose what fits your operation and your goals and objectives.
Finally, a word about sales for 2011 and 2012. We have not been strong advocates of this to this point. Personally, I am reluctant to make those sales without being able to lock in my input costs that far out. We all remember how amonia, seed, chemical, and fuel costs went up a few years ago, and doing one side without the other to me is risky. Small increments are fine, and to have some $10.00 beans sold for off the combine next year is certainly appealing to me, as I prefer not to store beans without some real carry in the market. Keep that in mind as well when considering your opportunities. Harvest is just around the corner, and our attention will be shifting to that task rapidly, so taking some time now to review your plan, update yield expectations, check on insurance coverage, etc., may well be worth your time. Call us with any ideas or questions!
Mike Daube    888-391-6330
Alan Gard      800-205-1700
Ron Reed      877-304-2460