Many risk management experts say situations like this summer show the unique value of put options.
The ability to protect high new crop prices while being locked into neither crop production commitments nor final prices has been ideal for many growers in the challenging environment this year.
“We went by profitability,” said Derek Squair, manager of Agri Trend Marketing, about his firm’s 2013-14 crop marketing strategy.
“Those targets were being met by $12.50 canola.”
Squair said his clients tend to have some crop priced through deferred delivery and futures contracts, but also bought put options earlier this year to increase coverage without having to worry about contracts that they might not be able to honour if the weather hurt production.
Put options protect against a falling market, but also keep the potential to benefit if the market rallies higher.
This summer has had unique pricing challenges for farmers. Prices have been on the high side of the historical range, but are lower than they were in the summer and early fall of 2012.
Some farmers have wanted to be able to catch a rally that could have resulted from any significant crop production problems this summer.
Crops across the Prairies went in weeks late, leaving farmers with greater than usual worries about crop maturity and first frost dates.
Many farmers haven’t wanted to tie up large portions of their crop in deferred delivery contracts or futures positions because they haven’t been sure they will be able to bring in the crop.
For many, that has created a marketing problem. Though crops are late, growing conditions are mostly favourable increasing the yield potential. The favourable conditions in Canada and in the U.S. Midwest have pushed prices far down from spring levels. Also, even if farmers priced a normal amount of crop in the spring, they might now have a much lower percentage covered just because of the good yields.
“We do hear horror stories of people being undersold,” said David Reimann, a risk management specialist at Cargill.
Cargill promoted put-based programs this year because of the potential for the high prices of 2012-13 to fall if good crops are harvested this year.
At the Grain World conference this winter, Reimann recommended farmers use put-based hedging because the market was volatile and could go higher, but downside risks were great.
“When you are looking at prices like we saw a year ago or over the past year, it’s always very good to protect them,” said Reimann.
“How do you take away that downside risk and leave yourself open for upside for a portion of your crops?”
That’s the role of put options, which give owners the right, but not the obligation to sell a certain amount of crop futures at a certain time for a certain price. If that price is above present market prices, the contract can be exercised or sold for a profit that compensates for the decline in market prices.
Squair said both market conditions and crop production challenges have made advisers alter their strategies this year to fit the conditions.
Other than using more put options, they have also already lifted some new crop futures hedges. The futures positions have been profitable, but instead of holding on to them until closer to harvest, they sold them at a profit so there’s no production risk.
By lifting the hedge, the farmer no longer needs to worry that his crop might fall short of his financial commitments, but still locks in some profit.
Overall, focusing on per acre profitability has turned out well this year, Squair said, since it allowed farmers and advisers to accept prices that might have seemed unappealing in the wake of 2012 prices.
“Yeah, prices could have gone to $13 (per bushel for canola), but it could also have gone down to $11, and if you’re profitable at $12.50, why not take it,” said Squair about the tenor of many springtime conversations he had. “Stick with the plan and lock in those profits.”