One thing for certain about wheat prices is that prices will change, and they will be volatile. Now is the time to design a strategy for selling 2012 harvested wheat.
The Kansas City Board of Trade (KCBT) December wheat contract price is about 38 cents higher than the KCBT July wheat contract price. This 38-cent price spread is a strong signal to store wheat at harvest until November. Other signals, however, indicate that wheat should be sold rather than stored.
Most grain elevators charge about $0.0013 per day ($0.04 per month) to store farmer owned wheat. Storing wheat from June 20 to Nov. 15 would cost about 19 cents per bushel (148 days X $0.0013).
If the wheat is sold at harvest, the proceeds may be used to pay production and harvesting costs for the 2012 crop and/or the costs to plant the 2013 crop. Production loan interest rates vary from producer to producer. For the example below, 5.5 percent interest is used.
If wheat is put in storage, the interest cost is about $0.00092 per day or about $0.028 per month. Storing wheat until Nov. 15 would cost about 14 cents per bushel.
The total cost to store wheat from June 20 to Nov. 15 would be 33 cents (19 cents + 14 cents). The market is paying 38 cents. The expected net profit from putting wheat in storage at harvest and selling the KCBT December wheat contract to protect the price compared to selling the wheat in June would be 5 cents per bushel.
Profit not guaranteed
The 5 cents profit is not guaranteed. The risk is the basis (difference between the cash price and the futures contract price). Any change in the basis will result in lower or higher profit, depending if the basis weakens or strengthens. If the difference (spread) between the cash price and the futures price strengthens (cash price increases more than the KCBT Dec contract price), profit from the hedge will be greater than 5 cents.
An alternative to creating a storage hedge (store wheat and sell futures) is to sell the wheat and buy KBCT December call option contracts. Buy one December contract for each 5,000 bushels sold.
If you want to use call options to simulate selling in one-third increments (harvest, last September, and mid-November), sell all the wheat. Then buy one December contract for each 7,500 bushels sold. One half of the calls may be sold in October and the other half in December.
The 33 cent storage and interest cost savings would be used to pay for the “at-the-money” KCBT December wheat call option contracts. If the December contract price increases between June and November, the value of the call option will also increase. The net price (cash price plus profit from the call option contract) received would also increase.
A third option is to just store the wheat and hope that wheat prices increase more than 33 cents between harvest and mid-November.
A strategy that is simple and tends to fit most producers' objectives is to sell one-third of the wheat at harvest, one-third in late-September or early-October, and the final third in November or December. This strategy provides cash to pay harvest costs. Cash is available for planting the next year’s crop. And, wheat is available to sell if wheat prices increase into the fall.
This third/third/third strategy allows producers to spread sales over time and to always be right, price wise. If prices are highest at harvest, one-third was sold. If prices are highest in the fall, one- to two-thirds of the wheat is left to sell.
Today’s market indicates that a storage hedge would produce a small profit from storing wheat. By harvest, the market signals will have changed and the strategy will have to be re-evaluated.