2008 k-state risk assessed marketing workshops grain marketing basics: cash grain basis, forward...
TRANSCRIPT
2008 K-State Risk Assessed Marketing
Workshops
Grain Marketing Basics: Cash Grain Basis, Forward Contracts, Futures & Options
Dr. Daniel M. O’Brien
Extension Agricultural Economist
K-State Research and Extension
Price Trend EffectsOn Cash Sales & Forward Contracts
Pricing Alternatives
Falling Futures
Rising Futures
Wider Basis
Narrower Basis
Cash Market Sales ( ) () ( ) ()
Forward Cash Contract None None None None
Basis Contract ( ) () None None
Hedge-to-Arrive (HTA) None None ( ) ()
Minimum Price Contract None () None None
Price Later Contract ( ) () ( ) ()
Price Trend EffectsOn Futures, Options & Marketing Loans
Pricing Alternatives
Falling Futures
Rising Futures
Wider Basis
Narrower Basis
Short Futures Hedge None None ( ) ()
Buy Put Options None () ( ) ()
Sell Cash & Buy Calls None () None None
Marketing Loans None () ( ) ()
Risk Exposure of Marketing ToolsA. Options Volatility Risk
Risk that option premiums will not change 1-for-1 with cash/futures as the price level changes
B. Production Risk if Pre-harvest Pricing Risk of being unable to deliver grain to fulfill a contract
C. Counter Party Risk Risk that a buyer wont fulfill their contract obligations
D. Control Risk Risk of market actions getting “out of control” before
corrective actions can be taken by the seller
?
Areas of Risk ExposureFor Cash Sales & Forward Contracts
Pricing Alternatives
Options Volatility
Prodn. Risk if
Prehvst.
Counter Party Risk
Control
Risk Cash Market Sales --- --- --- Yes
Forward Cash Contract --- Yes Yes ---
Basis Contract --- Yes Yes Yes
Hedge-to-Arrive (HTA) --- Yes Yes Yes
Minimum Price Contract Yes Yes Yes Yes
Price Later Contract --- --- Yes Yes
Areas of Risk ExposureFor Futures, Options & Marketing Loans
Pricing Alternatives
Options Volatility
Prodn. Risk if
Prehvst.
Counter Party Risk
Control
Risk Short Futures Hedge --- Yes --- Yes
Buy Put Options Yes Yes --- Yes
Sell Cash & Buy Calls Yes --- --- Yes
Marketing Loans --- --- --- Yes
Hedging With Futures
Price Hedges on Grain Production
1) (Prehedge) Analyze hedging opportunity Futures less Basis less Brokers’ fees
2) (Placing the Hedge) Sell futures contract(s) nearest to the grain delivery period In a “Short” or “sell” futures position
3) (Closing Out the Hedge Position)
Buy back futures contract(s)
Sell cash grain (optional)
Grain Forward Pricing Decisions How Much to Forward Contract or Hedge?
For Pre-Harvest Pricing: Max of 50%-75% of expected production (average yields)
If have a short crop, use Crop Insurance Coverage revenues to help fill Forward Contract obligations
Recommended: A disciplined grain marketing plan
What Time Period to Set Grain Delivery In? Examine Harvest vs Post Harvest Basis, Storage
Returns, and Grain Delivery Opportunities Timing of cash flow needs
Forward Contract Vs Futures Hedge If Basis Projection is Accurate, then..
Forward Contract $ = Futures Hedge $
Who Carries the Futures Account? FC: Elevator contacts broker & pays any margin calls Hedge: Producer works w. broker, pays margin calls
Delivery Commitment? FC: Delivery commitment of X bushels for $X price Hedge: No delivery commitment to elevator
Basis Commitment? FC: Set cash basis / Hedge: Varying cash basis
New Crop DEC 2008 Corn Examples for March 3, 2008
CBOT December 2008 Corn Prices
Futures Hedge for Harvest Delivery
Forward Contract for Harvest Delivery
Put Option Price Floor
Call Option Price Coverage
CBOT DEC 2008 CornJanuary 2006 – March 2008
2008 Preharvest Corn HedgeHedging on Monday, March 3, 2008 Target Sales Date: November 15, 2008
Corn Futures Price (3/3/08) December ‘08 CBOT Corn = $5.76 1/2
Expected Corn Basis $0.05-$0.25 under DEC CBOT Corn on November 15 th
2008 Corn Hedge Expected Price = $5.58 /bu
DEC 08 CBOT Corn - Basis - Broker $5.76 - $0.17 - $0.01 = $5.58
Cash Corn Basis: Dighton, KSYears 2005-2008
($0.40)
($0.30)
($0.20)
($0.10)
$0.00
$0.10
$0.20
$0.30
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46
Week of Year (Consecutive Order)
Basi
s (
Cash
- F
utu
res)
2008 2007 2006 2005
Cash Corn Basis: Scott City, KSYears 2005-2008
($0.30)
($0.20)
($0.10)
$0.00
$0.10
$0.20
$0.30
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46
Week of Year (Consecutive Order)
Bas
is (
Cas
h -
Fu
ture
s)
2008 2007 2006 2005
Cash Milo Basis: Dighton, KSYears 2005-2008
($0.70)
($0.60)
($0.50)
($0.40)
($0.30)
($0.20)
($0.10)
$0.00
$0.10
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46
Week of Year (Consecutive Order)
Bas
is (
Cas
h -
Fu
ture
s)
2008 2007 2006 2005
Cash Milo Basis: Scott City, KSYears 2005-2008
($0.70)
($0.60)
($0.50)
($0.40)
($0.30)
($0.20)
($0.10)
$0.00
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46
Week of Year (Consecutive Order)
Bas
is (
Cas
h -
Fu
ture
s)
2008 2007 2006 2005
New Crop Corn Hedge ExampleScenario A: Falling Corn PricesDate Cash Transactions
Futures Basis Expt. $: $5.58 ($5.76 - 0.18*) By November 15, 2008
On 3/3/08 No Cash Transactions
On 3/3/08 Expt Sell DEC 08 @$5.76 ($0.18)
On 11/15/08 Sell Cash Corn @ $3.58
On 11/15/08 Actual Buy DEC 08 @$3.76 ($0.18)
Net Gain/Loss on Futures: Gain of $2.00 /bu ( - $0.01 broker)
Final Net Price = $5.58 /bu Cash $3.58 + $2.00 Futures Gain
New Crop Corn Hedge ExampleScenario B: Rising Corn PricesDate Cash Transactions
Futures Basis Expt. $: $5.58 ($5.76 - 0.18*) By November 15, 2008
On 3/3/08 No Cash Transactions
On 3/3/08 Expt Sell DEC 08 @$5.76 ($0.18)
On 11/15/08 Sell Cash Corn @ $7.58
On 11/15/08 Actual Buy DEC 08 @$7.76 ($0.18)
Net Gain/Loss on Futures: Loss of $2.00 /bu ( - $0.01 broker)
Final Net Price = $5.58 /bu Cash $7.58 – $2.00 Futures Loss
2008 New Crop Corn Forward Contract Utica, Kansas Garden City Coop, Utica, KansasMar. 5, 2007 – Feb. 29, 2008Source: DTN Bid Analyzer
$5.47 /bu on 2/29/08FC Basis: $0.18 /bu underCBOT DEC 2008 Corn Futures
2008 New Crop Milo Forward Contract Utica, Kansas Garden City Coop, Utica, KansasMar. 5, 2007 – Feb. 29, 2008Source: DTN Bid Analyzer
$5.15 /bu on 2/29/08 FC Basis: $0.50 /bu underCBOT DEC 2008 Corn Futures
DEC 2008 Corn Put-Call Option Prices
$0.95 $0.92$0.85 $0.84
$0.70 $0.68$0.60
$0.54
$0.74$0.65$0.59$0.55
$0.49
$0.76$0.75
$0.00
$0.75
$1.50
$5.30 $5.40 $5.50 $5.60 $5.70 $5.80 $5.90 $6.00 $6.10 $6.20 $6.30
Strike Prices
Pre
miu
ms
/ Bu.
Put Option Premiums Call Option Premiums
DEC 2008 Corn Futures Close:$5.76 /bu on March 3, 2008
DEC 2008 Corn Put Option Values
$0.00
$0.30
$0.60
$0.90
$1.20
$1.50
$5.30 $5.40 $5.50 $5.60 $5.70 $5.80 5.9
Strike Prices
Pre
miu
ms
/ Bu.
Put Time Value Put Intrinsic Value
DEC 2008 Corn Futures Close:$5.76 /bu on March 3, 2008
"In the Money" Puts:Futures < SP
"Out of the Money" Puts:Futures > SP
DEC 2008 Corn Put Price Floors
$4.6
1
$4.6
5
$4.7
1
$4.7
5
$4.7
6
0.18 0.18 0.18 0.18 0.180.49 0.55 0.59 0.65 0.74
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
$7.00
$5.30 $5.40 $5.50 $5.60 $5.70 $5.80
Strike Prices
Pre
miu
ms
/ Bu.
Floor Price* Basis Put Premium Broker Fee
At the Money: $5.76 /bu (3/3/08)
Results of Buying a $5.30 DEC 2008 Corn Put Option @ $0.49/bu
$3.58$4.08
$4.58$5.08
$5.58$6.08
$6.58$7.08
$5.07 $5.07 $5.07 $5.07 $5.07$5.57
$6.07$6.57
-$1.00
$1.00
$3.00
$5.00
$7.00
$9.00
$3.76 $4.26 $4.76 $5.26 $5.76 $6.26 $6.76 $7.26
Futures Prices
Net
Ret
urns
/ B
u
Cash Price Net Put Return Net Price Received
DEC 2008 Corn Call Option Values
$0.00
$0.30
$0.60
$0.90
$1.20
$1.50
$5.30 $5.40 $5.50 $5.60 $5.70 $5.80 $5.90 $6.00 $6.10 $6.20 $6.30
Strike Prices
Pre
miu
ms
/ Bu.
Call Time Value Call Intrinsic Value
DEC 2008 Corn Futures Close: $5.76 /bu on March 3, 2008In the Money Calls:
Futures > SP
Out of the Money Calls:Futures < SP
DEC 2008 Corn Call Price CoverageMinimum Price Increase Needed to Cover Call Premium Cost
$5.4
0
$5.5
0
$5.6
0
$5.8
0
$5.9
0
$6.0
0
$6.2
0
$6.3
0
$5.3
0
0.540.600.680.700.750.840.850.920.95
$0.00
$1.50
$3.00
$4.50
$6.00
$7.50
$9.00
$5.30 $5.40 $5.50 $5.60 $5.70 $5.80 $5.90 $6.00 $6.10 $6.20 $6.30
Strike Prices
Pre
miu
ms
/ Bu.
Strike Price Call Option Premiums Broker Fee
At the Money: $5.76 /bu (3/3/08)
Results of Buying a $5.80 DEC 2008 Corn Call Option @ $0.75 /bu
$0.50$1.00
$1.50$2.00
($0.77) ($0.77) ($0.77) ($0.77)($0.27)
$0.23$0.73
$1.23
-$1.50
$0.00
$1.50
$3.00
$4.50
$4.26 $4.76 $5.26 $5.76 $6.26 $6.76 $7.26 $7.76
Futures Prices
Net
Ret
urns
/ B
u
Call Purchase Price Call Selling Price Broker Fee Net Call Returns
DEC 2008 Corn Futures Close:$5.76 /bu on 2/26/08
New Crop NOV 2008 Soybeans Examples for March 3, 2008 CBOT November 2008 Soybean Prices
Basis History (2005-2008)
Futures Hedge for Harvest Delivery
Put & Call Option Premiums
CBOT NOV 2008 SoybeansJanuary 2006 – March 2008
Cash Soybean Basis: Dighton, KSYears 2005-2008
($1.60)
($1.40)
($1.20)
($1.00)
($0.80)
($0.60)
($0.40)
($0.20)
$0.00
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46
Week of Year (Consecutive Order)
Basi
s (
Cash
- F
utu
res)
2008 2007 2006 2005
Cash Soybean Basis: Scott City, KSYears 2005-2008
($1.60)
($1.40)
($1.20)
($1.00)
($0.80)
($0.60)
($0.40)
($0.20)
$0.00
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46
Week of Year (Consecutive Order)
Bas
is (C
ash
- Fut
ures
)
2008 2007 2006 2005
2008 New Crop Soybean Frwd. Contract Utica, Kansas Garden City Coop, Utica, KansasMar. 5, 2007 – Feb. 29, 2008Source: DTN Bid Analyzer
$13.14 /bu on 2/29/08FC Basis: $1.10 /bu underCBOT NOV 2008 Soybean Futures
NOV ‘08 Soybean Put-Call Option $s
$2.40
$2.10 $2.15
$1.78 $1.72$1.77$1.63$1.56$1.43$1.34
$0.00
$1.00
$2.00
$3.00
$13.40 $13.60 $13.80 $14.00 $14.20 $14.40 $14.60 $14.80 $15.00 $15.20 $15.40
Strike Prices
Pre
miu
ms
/ Bu.
Put Option Premiums Call Option Premiums
NOV 2008 CBOT Soybean Close:$14.47 /bu on March 3, 2008
NOV 2008 Soybean Put Price Floors
$10.
94
$11.
05
$11.
12
$11.
25
$11.
31
1.10 1.10 1.10 1.10 1.101.34 1.43 1.56 1.63 1.77
$0.00
$3.00
$6.00
$9.00
$12.00
$15.00
$18.00
$13.40 $13.60 $13.80 $14.00 $14.20 $14.40 $14.50
Strike Prices
Pre
miu
ms
/ Bu.
Floor Price* Basis Put Premium Broker Fee
At the Money: $14.47 1/2 /bu (3/3/08)
NOV 2008 Soybean Call Price CoverageMinimum Price Increase Needed to Cover Call Premium Cost
$14.
00
$14.
20
$15.
00
$15.
40
2.40 2.10 2.151.78 1.72
$13.
40
$0.00
$3.00
$6.00
$9.00
$12.00
$15.00
$18.00
$21.00
$13.40 $14.00 $14.20 $15.00 $15.40
Strike Prices
Pre
miu
ms
/ Bu.
Strike Price Call Option Premiums Broker Fee
At the Money: $14.47 1/2 /bu (3/3/08)
New Crop July 2008 HRW Wheat Examples for March 3, 2008 KCBT July 2008 HRW Wheat Prices
Basis History (2005-2008)
Futures Hedge for Harvest Delivery
Put & Call Option Premiums (2/22/08)
KCBT JULY 2008 HRW WheatFebruary 2007 – March 2008
Cash Wheat Basis: Dighton, KSYears 2005-2008
($1.40)
($1.20)
($1.00)
($0.80)
($0.60)
($0.40)
($0.20)
$0.00
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46Weeks during Year (Consecutive Order)
Bas
is (
Cas
h -
Fu
ture
s)
2008 2007 2006 2005
Cash Wheat Basis: Scott City, KSYears 2005-2008
($1.20)
($1.00)
($0.80)
($0.60)
($0.40)
($0.20)
$0.00
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46
Week of Year (Consecutive Order)
Bas
is (
Cas
h -
Fu
ture
s)
2008 2007 2006 2005
2008 New Crop Wheat Frwd. Contract Utica, Kansas Garden City Coop, Utica, KansasMarch 5, 2007 – Feb. 29, 2008Source: DTN Bid Analyzer
$10.30 /bu on 2/29/08FC Basis: $0.60 /bu underKC July 2008 Wheat Futures
JULY ‘08 HRW Wheat Put-Call Option $s
1.251.37 1.431.42 1.37 1.32 1.27 1.22
1.001.14
1.081.030.980.930.88 0.920.961.04
1.13
$0.00
$0.70
$1.40
$2.10
$10.40 $10.50 $10.60 $10.70 $10.80 $10.90 $11.00 $11.20 $11.30 $11.40 $11.50
Strike Prices
Pre
miu
ms
/ Bu.
Put Option Premiums Call Option Premiums
JULY 2008 KCBT Wheat Close:$10.99 /bu on March 3, 2008
JULY 2008 KC Wheat Put Price Floors
$9.0
0
$9.0
5
$9.1
0
$9.1
5
$9.2
0
$9.2
4
$9.3
3
$9.4
1
$9.4
5
0.60 0.60 0.60 0.60 0.60 0.60 0.60 0.60 0.600.88 0.93 0.98 1.03 1.08 1.14 1.25 1.37 1.43
$0.00
$3.00
$6.00
$9.00
$12.00
$15.00
$10.50 $10.60 $10.70 $10.80 $10.90 $11.00 $11.20 $11.40 $11.50
Strike Prices
Pre
miu
ms
/ Bu.
Floor Price* Basis Put Premium Broker Fee
At the Money: $10.99 /bu (3/3/08)
JULY ‘08 KC Wheat Call Price CoverageMinimum Price Increase Needed to Cover Call Premium Cost
$10.
50
$10.
60
$10.
70
$10.
80
$11.
00
$11.
20
$11.
30
$11.
40
$11.
50
1.15 1.37 1.32 1.27 1.22 1.13 1.04 1.00 0.96 0.92$1
0.40
$0.00
$3.00
$6.00
$9.00
$12.00
$15.00
$10.40 $10.50 $10.60 $10.70 $10.80 $11.00 $11.20 $11.30 $11.40 $11.50
Strike Prices
Pre
miu
ms
/ Bu.
Strike Price Call Option Premiums Broker Fee
At the Money: $10.99 /bu (3/3/08)
Concluding Thoughts
on Grain Marketing
Goals, Plans & Strategies
Goals in Grain Marketing
A. Price Improvement To raise average grain selling price
B. Price Risk Reduction To reduce seller’s downside price risk
C. Average Pricing via Sequential Sales
D. Financial Management Oriented Goals Enterprise cost or whole farm profit objectives
E. Combination Goals Difficult to enhance price AND reduce risk
Improving the Selling Price of Grain Farmer’s Most Common Marketing Goal:
To improve average grain selling price!
To maximize grain selling price subject to the need to manage harmful downside price risk
Specific Goals: Getting better than the... Average price available
Middle (50%) price available
Harvest price
Reducing Grain Price Risk
A. Goal: Reducing price risk by protecting from harmful price moves
To maximize grain selling price subject to the need to manage harmful downside price risk
B. Grain Sellers are motivated to: Protect themselves from downside price risk Possibility profit from price increases
C. Tools for Reducing Grain Price Risk: Forward Contracts & Hedges: To lock in prices MPCs & Put Options: To set price floors
Average Pricing via Sequential Sales Deliberately pricing portions of the crop at
different times of the marketing year
Average Pricing….(+) AVOIDS selling 100% at market LOWS
(–) ALSO AVOIDS selling 100% at market HIGHS
Benefits of Average Pricing: Adds structure & discipline to marketing plans Is a form of price risk management
Combining Grain Marketing Goals Difficult to both Enhance Prices & Reduce
Price Risk at the same time Example: Higher returns & price variability from pre-
harvest futures hedges vs. buying put options
Principle of Price Risk Management Higher net grain selling prices will tend to be
sacrificed in terms of lost pricing opportunities or the cost of managing price risk
If Prices : Cash Sales > Options-Fwd. Contracts If Prices : Fwd. Contracts > Options-Cash Sales
Types of Grain Marketing Strategies1) Routine Strategies
Grain marketed each year at the same time using the same marketing tools regardless of market conditions
• Example: Preharvest hedge 1/3 of exp. production, sell 1/3 at harvest, store rest on farm for 6 months then sell
2) Systematic Strategies Allowing for yearly variation in marketing actions
based on Key Market Indicators
• Key #1: Preharvest Prices vs. CCC Loan Rates• Key #2: Years following Short Crops
Types of Grain Mktg. Strategies (more)3) Strategies Using Expert Forecasts
When people profit from their superior ability to forecast grain market trends & marketing decisions
• In general, it is difficult for individuals to predict market price direction better than other market participants
4) Strategies Using Market-Based Forecasts Using futures, options & basis information as key
market indicators for making marketing decisions
• Key #1: “Wide” Cash Grain Basis @ harvest• Key #2: “Higher / Lower than normal” preharvest
hedge profits
How Efficient are Grain Futures Markets at Determining Grain Prices? How Efficient are Grain Markets?
Define “Market Efficiency”
Opinions: From Very to Moderately Efficient
Key Issue: “Do Grain Marketing Strategies Exist that are more profitable than selling at harvest?”
The degree of Futures Market Efficiency will affect choice of Grain Marketing Strategies
Marketing Challenges & BenefitsA. The Challenge of Grain Marketing Decisions
It is Difficult to obtain higher grain selling prices!!
B. Grain Marketing’s Relative Importance(K-State Study of KFMA Farms for 1987-1996)
High 1/3 vs Middle 1/3:Yields: +17%; Costs: –37%; Prices +12%, More Notill
Low 1/3 vs Middle 1/3:Yields: –18%; Costs: +28%; Prices –12%, Less Notill
Study Critique: Not measuring effectiveness of marketing practices used, only Hi/Lo Profit
C. Production is 1st priority; Marketing #1.A
Futures Margins Initial Margin Deposit:
Required up front, good faith deposit by exchanges
Margin Account Losses/gains in futures position reflected here Minimum required margin account balance
Margin Deposit Additional money required when margin account falls
below minimum balance due to losses in futures position
Wheat Margin Deposit ExampleSell 5,000 bu July KCBT Wheat @ $10.50/bu on 2/5/08
Prices Trend Up2/5:Sell $10.50 KC July Wheat Initial Deposit = $1,500
Minimum Deposit = $1,000
6/1: KC July Wheat @ $11.50
Loss in Futures ($5,000)
Account balance ($3,500)
Margin Call +$4,500
New Account balance = $1,000
Prices Trend Down2/5:Sell $10.50 KC July Wheat Initial Deposit = $1,500
Minimum Deposit = $1,000
6/1- KC July Wheat @ $9.50
Gain in Futures +$5,000
Account balance $6,500
Margin Call = $ 0
New Account balance = $6,500
Questions or Comments?
K-State Agricultural Economics Department Website:
www.Agmanager.Info