Hedging with U.S. futures and options tricky but possible

Finding perfection in futures markets is an impossible task.

However, brokers and traders say North America’s main futures contracts can provide good risk management, even if they sometimes take a bit of engineering and TLC.

“A lot of times it’s never going to be a perfect hedge, especially with wheat, but it’s giving you some protection,” said P.I. Financial broker David Derwin.

Western Canadian farmers have only one futures contract specifically designed for a crop they grow.

With the delisting of ICE Futures Canada’s spring wheat, barley and durum contracts, only canola futures and options exist as contracts based on Canadian-grown crops with a delivery area in Western Canada, denominated in Canadian dollars.

All other contracts commonly used by risk managers are based in the United States, trade in U.S. currency and have many underlying U.S. assumptions. That makes them indirect hedges for Canadian farmers.

“It’s not a straight-on hedge by any means,” said Errol Anderson of Pro Market, about southern Alberta feeders using the Chicago corn contract to hedge their feedgrains exposure.

However, Anderson and Derwin both said they are confident using Minneapolis, Kansas and Chicago wheat contracts and happy with Chicago soybean and corn contracts.

“It’s the king of the grains,” said Anderson about Chicago corn. Alberta feedlot operators import some U.S. corn and buy lots of barley, so feedgrain hedging is a constant interest for them.

Chicago corn futures aren’t perfect for protecting Alberta-delivered corn prices, but they’re close. And while barley values diverge significantly from Midwestern U.S. corn prices, corn futures can cover the biggest feed price moves and combining them with wheat contracts can sometimes approximate barley values.

“If you get extreme price moves, you’re buying into grain prices in general,” said Derwin.

For wheat, hedging is always a challenge. Not only are the three U.S. contracts traded in American currency, but also represent types and specifications of wheat that might not apply to grain a prairie farmer wants to hedge.

Protein levels and grade vary widely within wheat crops, so using U.S. futures contracts can be an art in terms of pulling together a reliable hedge for the real world.

However, Derwin and Anderson said they are happy with U.S. wheat futures and options.

Both like using options.

Minneapolis hard red spring wheat options often offer a good hedge for Canadian prairie wheat growers, but the Minneapolis contract has much less trade than the Chicago soft wheat or Kansas winter wheat contracts. Anderson said that means hedgers using Minneapolis have to be patient.

“Sometimes there’s a delay,” he said about posting interest in an options contract.

“It might take a couple of days.”

Derwin said he’ll also use Chicago oat options, even though many traders worry about the contract’s low trading volumes.

“In an extreme price situation, you can still use them and still get the benefit,” he said.

The oat futures contract is not good at tracking small moves in the prairie oat cash market, but big changes in the underlying value of oat are ultimately reflected in the futures and options.

While ICE Futures Canada has only one crop futures contract left, it’s a good one, the brokers said.

Canola futures and options work great for hedging.

“It is grown in Canada. It was developed here. It’s in Canadian dollars,” said Derwin.

The contract well reflects the commercial cash market situation in Western Canada, it trades robustly and there’s no currency exchange situation to worry about.

Anderson said there are no problems getting into and out of futures positions, and it isn’t difficult to find somebody for an options position.

“The canola options trade really well,” said Anderson.

With the ending of Winnipeg’s foray into spring wheat and durum futures, and the final killing shot given to the suffering barley contract, prairie farmers have fewer homegrown tools for risk management.

Indeed, farmers didn’t use them even when they were available.

But marketing experts like Anderson and Derwin said the tools they have are good, even though they are not customized for the exact crops their clients grow.

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