Lock In, Yet Enjoy Rallies

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If you didn't lock in 2010 prices at higher levels, this year is one when it makes sense to look for ways to have your cake and eat it too. Although prices are lower than last year and may be headed even further south, many farmers are reluctant to price on the hope that a weather event might occur.

"Everyone wants to build a strategy that stops the bleeding,” says Bill Biedermann of Allendale. "Yet because of the sell off and the potential upside risk, everyone wants a strategy that will allow their income to gain if the market rallies. This can be done in several ways.”

In fact, with December futures at $3.95, a -20¢ basis and a 170-bu. corn yield, you could lock in more than $600 an acre and still do better if prices rally, Biedermann found using a computer program called the Evaluator that tests strategies at different price levels. It includes costs, such as options premiums, interest on margin money and commissions when applicable.
Comparison. Some of the strategies Biedermann compared are relatively new, unregulated over-the-counter swaps offered by Allendale, R.J. O'Brien and others. They allow you to set the parameters you want given trade-offs between cost, protection and upside potential.

When Biedermann did this comparison, December futures were trading at $3.91¾. The best performer given a $3 to $5 corn price range was an accumulator contract, he reports. You assign a number of bushels to the program and choose a time period. Each day in the time period that prices are between $3.43½ and $4.30¾, you price one "unit” (number of bushels you specify). If prices trade more than $4.30¾, your pricings are doubled up. If prices fall below $3.43½, you don't sell anything. In Biedermann's analysis, the accumulator resulted in a $677 per acre price. The drawback, he says: "You won't know until the end of the pricing period how many bushels you sold via this program.”

"If you want to know where you are, an options box [buy $4 put and sell a $4.50 call for a net cost of 21¢ per bushel] or a three-way [buy a $4 put for 29¢, sell a $4.50 call for 50¢ and sell a $3 put for 10¢] look good,” Biedermann says. "These lock in over $600 an acre income and then you can improve it, such as double up your sold position if prices get above $4.50 [as the accumulator would].” In fact, he notes, if we had a spring or summer rally to $4.75 and you sold futures there, then prices fell below $3.50 in the fall, you would make more than $800 an acre.

Floored average contracts set a minimum price, but if the market trades higher, you get the higher daily market price. In the example, the floor was $3.91¾ (basically a put option at a cost of 34¢). Each day prices trade higher than that level, that day's settlement price would be used.

Table: Strategies from Traditional to Innovative

Top Producer, March 2010