– In the beginning of July, Justin Topp thought he had sold about a quarter of his bean crop for delivery at harvest. After a dry summer caused yields to dwindle into the mid-30s bushels per acre, it looks as if that will be more like 30% to 40% of his crop.
“We were pretty fortunate to have quite a few beans sold to go to town, but everything else is going to get stored,” the Grace City, North Dakota farmer said. He can’t recall a time when the farm has put as many bushels of soybeans in storage. With local cash prices well below break-even levels at $7.60 per bushel, he doesn’t have much choice.
“Our basis is so bad up here, we just hope that something gets done,” he said. “I think it’s just going to be a hold and wait-and-see approach for us to see what’s going to happen with the trade deal.”
China’s tariff on U.S. soybeans has put farmers across the Northern Plains and upper Midwest in the unfamiliar situation of storing — instead of selling — soybeans at harvest. The damage to futures prices and basis has made marketing particularly tough, but experts say there are steps farmers can take to minimize downside risk and capture the carry in the market.
In our “Tariff Realities” series, DTN is looking at challenges facing U.S. farmers and grain elevators this fall as they market, store and transport soybeans under conditions related to China’s 25% retaliatory tariffs. Even as the trade dispute continues, the market has to absorb a projected record soybean crop of 4.69 billion bushels and larger-than-expected stocks of 438 mb of old-crop beans.
EARN THE CARRY
The soybean market offers a substantial carry — when subsequent future contracts trade at a progressively higher level than current issues — but a farmer has to take action in order to earn the carry that the market is offering.
“The carries that are being promised to you by the marketplace are not realized unless you sell the carry,” said Kent Beadle, CHS Hedging director of risk consulting services. For a farmer that has already sold soybeans on the futures board, that means buying back their hedge in the November contract and selling a later issue, like the May, July or August. “By doing that you essentially add the amount of the carry to the underlying futures price.”
Farmers who don’t have any hedges in place need to start mapping out realistic objectives and plans for when to pull the trigger on sales. Beadle said there are a number of tools farmers can use in this situation: selling futures, buying put options or using more complex options strategies.
Selling futures gives farmers a certain amount of control. They can exit the position without delivering grain, roll the position forward as many times as they want, and then pay a smaller fee than what most elevators charge for a hedge to arrive contract.
“Using futures also gives you the flexibility about the direction in which those soybeans are marketed,” Beadle said. “If you happen to be in the middle of two different elevators, plus a processing plant, for example, once you’ve set the futures, you can essentially monitor the basis at all three places and make the decision as to which market is the best market to go into.”
Another tool is put options, which establish a minimum selling price while leaving upside open if the market moves higher. Put options for soybeans tend to carry a higher premium than put options for corn because the market tends to be a little more volatile. Puts also become more expensive the closer the strike price gets to the market price of futures.
DTN Analyst Todd Hultman said an example move could be buying an out-of-the-money $7.60 November 2019 soybean put that costs about a nickel but eliminates 80% of the downside price risk. “It’s not a big financial commitment, but it takes a lot of the downside risk out and allows us to hang in there until we can get to a better time of year to look for a price.”
For farmers that want to establish a price floor closer to the market or their cost of production, one strategy to reduce the premium price is to buy a put and sell calls above the market, Beadle said. For example, a producer could buy a $9 July 2019 soybean put and sell a $9.80 July 2019 soybean call. That gives the producer a minimum selling price of $9 with 80 cents of potential upside gain.
“You’re going to pay less for that floor because you were willing to accept the ceiling,” he said.
MANAGE MARGIN CALLS
Futures and options come with a downside: margin requirements and the potential for margin calls if the market moves higher. Margin makes a lot of farmers uncomfortable, Beadle said.
“It requires working capital, and it can chew up some of your working capital if the market starts going higher and you have to make margin calls,” he said.
Not all farmers fear margin calls. Northeast Iowa farmer Erik Oberbroeckling cheers for them.
“It’s kind of counterintuitive,” he said. It means the market it going up and you can sell your cash grain at a better price. One of the keys to avoiding heartburn over working capital is to establish a separate line of credit for hedging. That way, instead of worrying that you’ll max out your operating loan and have to liquidate your hedges, “you know that money is there and that’s what it’s there for.”
Some hedging services have financial units that can create hedging accounts for clients that qualify. Farmers also would need to work with lenders to create financing to support hedging actions.
Oberbroeckling, who regularly uses options in his marketing plans, said he included his broker in his initial conversations with his banker about setting up a hedging account. He had to explain what he wanted to do, why he wanted to do it and the potential risks of his strategy.
“The banker has to have enough trust in the farmer that the farmer’s going to run it the way he advertised it, not turn it into a speculation account instead of a hedge account,” Oberbroeckling said.
OPTIONS STRATEGIES REQUIRE DISCIPLINE, LONG-TERM PERSPECTIVE
Discipline is another essential part of using options strategies.
“You have to essentially sell every bushel twice,” Oberbroeckling said, once when you execute the option strategy and then again when you sell the bushel into the cash market. “And for some people it’s hard enough pulling the trigger to sell it once.”
Others are gun-shy to use futures and options after the market run-up in 2011 to 2013 left them with grain sales priced well below market value. Beadle urges those farmers to take a long-term view. Yield came in below trend line those three years, but they’ve been above trend for the last five.
“The farmers that I work with, over the long run, by following this type of strategy year after year after year, no matter what the ultimate outcome, they find that they do a better job,” he said. “Over 10 years, you’re going to have a higher marketing price than worrying about what might happen in those few years where our production ends up being below trend and the prices end up being higher.”
Beadle acknowledges that every farmer is different, with unique finances and appetite for risk. Futures and option strategies aren’t right for every farmer. “The farmer needs to know what he’s comfortable with and what he isn’t,” he said.
If futures and options strategies aren’t right for you, be sure to read Tariff Realities – 5 for a review of hybrid cash contracts, which are offered by many elevators and other grain buyers. It will be published Oct. 5.