Three options in corn marketing plan

If you're selling your own corn in 2002, the marketing options can be condensed into three basic strategies — wait until tomorrow, lock in the price today, or put a floor under the price but not a ceiling.

“If you're managing your own marketing, you basically can do one of these three things at any one time on any given day — marketing is not that complex,” says Charles Curtis, Clemson University Extension economist.

The “wait until tomorrow” option is the most utilized marketing strategy, says Curtis. “If you're a rational businessman, this says that you think tomorrow will be better than today. Farmers aren't gamblers, they're just optimists — maybe optimistic gamblers. The beauty of waiting until tomorrow is if the markets rise, then you were right,” he says.

A second option is that the grower can lock in the price today, he continues. “As a rational business decision, this is saying that things are just about as good as they're going to get. And if you look at about March 1, this typically is one of the most opportune times to price corn,” says Curtis.

In the extreme short-term, prices have tended to rise somewhat from the end of January, he says. The price bottoms out in January because growers are marketing through “tax management,” he adds.

“We hold the crop until the first of the year, and then we won't sell because the accountants told us that we want that income in 2002 rather than in 2001,”according to Curtis.

Growers throughout the United States, he says, are making planting decisions, and these decisions have been slower this year due to the uncertainty of a new farm bill.

“Sooner or later, we'll have to make our planting decisions. Usually, the markets are trying to “buy in” enough acreage, and we've tended to see a nice March rally in corn prices. History tells us that it might not be a bad thing to lock in the March price and let it go,” says the economist.

A third marketing alternative, which is a hybrid of the first two, is to utilize commodity options and put a floor under the price but not a ceiling, says Curtis. This option, he adds, can be done in two ways in the Southeast.

“You can purchase a put option, which gives you a floor. It'll protect you from the downside. But if the market runs higher, you can take advantage of the higher market prices.

“An alternative to this strategy is called a ‘synthetic put.’ You can go ahead and contract your grain for harvest or post-harvest delivery out of your storage. You can contract it, lock in a price and then purchase a call option, which again will open up the top. Both of these concepts work similarly in that they lock in a floor but not a ceiling.”

To take a closer look at how these strategies might perform in the marketplace, Curtis uses a hypothetical situation that includes a futures price of just under $2.36 per bushel. He uses Camilla, Ga., as a pricing point.

“Based on an analysis of south Georgia bases, Camilla typically is taken at harvest and delivered to the elevator at about 12 cents over. We're assuming, then, that the elevator will give you a $2.48 cash contract.

“The put option — the one that puts in the floor — is paid for up front. If we're looking at a $2.30 put option, it'll cost you just under 14 cents plus transaction costs. If we're 12 over on the cash contract, the put option will cost us a little bit more, so we ought to be about even for the futures.”

Growers need to know, says Curtis, what they need from the market.

According to Clemson enterprise budgets, the total cost of 175-bushel-per-acre irrigated corn is about $434 per acre, including debt management on the irrigation equipment. Using this calculation, it'll cost about $2.48 per bushel to cover total costs, he says.

“When looking at the options market, we need to know the potential for price change. What are the traders in the marketplace thinking in terms of prices going up or down and by how much? Right now, the market has assumed about 18 percent volatility.

“With a futures market at $2.36, two standard deviations will take us down to $1.51 and up to $3.21. The significance of two standard deviations is that there's about a 97 percent chance that the price will be in that range, and that's a widespread range.”

Weather forecasts, says Curtis, already are affecting the market. Some meteorologists are predicting a hot, dry growing season for the Midwest Corn Belt.

“Based on market probability, there's another 45 percent chance that we will see corn prices at $2.48 or higher. There's a significant gap at around $2.60, and there's about a 30 percent chance that we could achieve that gap, and that's due strictly to weather uncertainties.”

If a grower locks in a price today, at a cash contract with a futures hedge — with futures being $2.36 — he'll get a price in the $2.50 range, regardless of what happens to futures prices beyond today, explains Curtis.

“That is right on the total cost of production, if we get 175 bushels per acre from irrigated corn. If you use the ‘wait until tomorrow’ strategy, and the market falls down to $1.51, you'll be selling your corn at cash market for about $1.65. If the market runs up to $3.21, you'll be selling your corn for about $3.30.”

The options strategy, says Curtis, would be to set a floor at about $2.30 to $2.40. “If the market improves, you take advantage of the higher market range. Now you've got a situation where you've locked in something that's close to what you'll need to cover total costs, assuming you achieve the desired yields.”

Growers also can use the government loan program to their benefit in marketing corn, he says.

“We've done a lot of work collecting data from posted county prices and comparing that to futures prices. In a nutshell, what we've found over the last three years, when we've had a loan deficiency payment, is that we can predict the posted county price by taking about 25 cents off the market price.

“So, if the market price now is $2.25, we can predict the posted county price would be $2. If we compare that to the $2.09 loan rate, we can predict a nine-cent loan deficiency payment. Using this as a basis, we can predict posted county prices and loan deficiency payments over a wide range of prices.

“If, for example, we get down to that $1.51 price, then there would be an LDP of 84 cents. About the time futures prices get to the $2.30 to $2.35 range, we could predict that we probably won't have an LDP. With a $2.36 futures price — and if the 25 cents holds — we'll go into harvest without an LDP. But if the market falls and prices decline, you're gaining on an LDP.”

If a grower has protected himself in the market with put options, and prices fall, then he'll be gaining a penny for every penny lost, and the loan deficiency payment will be added in, says Curtis.

“In a sense, you'll be getting two pennies for every one penny that the market falls. There's a good benefit when we add the LDP to these three basic marketing strategies. At lower prices, as we move down, we're gaining LDP.

If we do nothing, the loan program is compensating for decreases in prices.

That's where the government basically gives you a free put. It gives you a floor but not a ceiling.”

But growers can do even better, he says. “If we hedge now and prices fall, we can get the ‘two for one.’ You can gain in the short futures position, and you can gain in the LDP. But if market prices rise, these flatten out because you're now making margin calls and your LDP's are gone.”

Based on the utilization of a $2.30 corn call, a grower can assure himself of a floor of about $2.38, says Curtis.

“That's not covering your total costs, but it's close. You can assure yourself of $2.38 and — here's the sweet part — if the market goes up or down, you do better. You're protected with this strategy. and you hope prices either fall or rise, but that they do move. The worst you can do is $2.38. If the Midwest experiences problems, you could sell at $3.20. All you have to do is purchase an option right now. This strategy is unique because of the existence of the marketing loan program.”

Growers might look to the March rally as a good time for putting this strategy to work, he says.

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