Canola growers who need cash now have to make a difficult call.
Do they accept the poor price they are going to be paid for any nearby deliveries of their crop and be satisfied, or do they make the cash sale and then risk some of the money by buying their crop back with options or futures?
Marketing advisers say for a crop replacement strategy to work, farmers must be able to restrain their own natural inclinations.
“For farmers, the moment they walk out that door (after accepting a low price for their crop) they’ve got one thing on their mind: it’s going to start going up tomorrow. That’s human nature,” said Union Securities broker Ken Ball.
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“But you need to be patient. We could be a day away from a low, or three months away from a low.”
Crop replacement strategies are valuable for farmers who need cash right away, but who don’t want to give up the chance of cashing in on a rising market later in the crop year.
Under this strategy a farmer sells his crop for cash now, then buys futures or options and waits to see if the price recovers, at which point he can sell his contract and make up some ground lost on the cash price.
But to do it right, a farmer needs patience, perseverance and luck. A crop replacement strategy may take months to pay off, and indeed may never pay off if prices don’t rise over the winter.
Errol Anderson of Pro Market Communications thinks this is a great year to try a crop replacement strategy, because he has little doubt that crop prices will rebound significantly after hitting their lows in a few weeks.
“If you’re able to wait her out at these lows, eventually you’ll be able to make money,” said Anderson.
Ball isn’t so sure.
“Sometimes it’s better to do that in a year when prices are stronger and more vibrant than it is in a year when prices are quite depressed.”
But they agree it is necessary for a farmer to wait for the true lows to be hit before taking out a futures and options position to replace the crop he has just sold in the cash market. Buying now could leave the farmer watching prices fall further because canola futures could drop to $240 or $250 per tonne. That would leave them with a big mountain to climb before they made any profit.
“You have to be patient and wait for the market to bottom out and level out and show some signs of life,” said Ball.
The choice between using futures or options is another decision farmers need to make. Futures have little up front cost but leave farmers exposed to margin calls, which can be costly to cover.
“A lot of growers find themselves more and more frustrated as they have to keep writing cheques for their futures position,” said Ball.
On the other hand, many farmers hate to pay for an options premium that they will never get back, even if the options position makes them money.
Anderson, who specializes in options strategies, doesn’t recommend using Winnipeg Commodity Exchange canola options because they are expensive and non-liquid. He prefers Chicago Board of Trade soy oil options, which are cheaper and easier to trade.
Ball said the same about Chicago soybean contracts.
They are likely to be more lively this winter, because the most likely cause of significant price movement will be the South American soybean crop, which is only partly factored into canola futures.
Anderson said close-to-the-money soy oil options will cost about $900 per rail car load, which is about 3,000 bushels.
Ball said farmers need to decide why they think prices will go up later this year before considering a crop replacement strategy. If they can’t answer that convincingly, they shouldn’t go any further.
“I only advise a few farmers to try it.”
