The recent slump in crop prices has alleviated one dilemma farmers had been facing: do they lock in new crop prices when their crops look so iffy?
With the exception of canola, whose rally was impeded by the concurrent run-up in the Canadian dollar, the other main crops experienced a heady May rally. A sharp drop in June, removed much of the temptation to price now.
But the dilemma will remain as the crops struggle along toward harvest, especially if a traditional summer rally occurs. Even if conditions are great from here on out, most crops are seriously delayed and face the risk of frost.
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So how much risk is there in hedging? Hedging is supposed to remove risk, but with many questions about the crop, traditional hedging practices can appear risky.
That makes alternative and more complex strategies especially attractive this year, two senior marketing advisers say.
“You’d have to be crazy to just go out there and strictly hedge futures,” said Joe Victor of Allendale, Inc. of McHenry, Illinois.
“You have to cover that short hedge with a long call option.”
Charlie Pearson of Alberta Agriculture said farmers can’t afford to get too aggressive with futures in an environment where the crop might fail.
“This is a year where you might want to consider those alternative strategies,” said Pearson.
Some grain companies offer minimum price contracts, which are a way to take advantage of rallies without incurring undue risk.
And buying put options locks in the ability to protect a price against a falling market, without the exposure to futures contract margin calls and naked exposure if the crop fails.
“You’re guaranteeing that, if prices are up and you feel you should do something, and you can see profit, and you’re more comfortable with your crop (as the summer progresses), but you still think things could go higher, you can at least establish a minimum price and from there play the market out a bit,” said Pearson.
Victor’s outfit has pushed a strategy designed for volatile times called a “box option spread” for three years now.
Essentially, it is writing a call option at a price level considered to be upper resistance and writing a put option at lower support, then using the proceeds to buy a put option at a closer-to-the-money level you want to protect.
It’s a way of safely locking in most of a minimum price and opening up a window for gains, capped by the call option you’ve written.
It’s not as simple as selling futures contracts, but it’s safer. That’s reassuring for the farmer and for the farmer’s bankers who are becoming increasingly demanding about risk minimization.
For a year of weird weather conditions in the U.S. and Canada, alternative hedging strategies might make a sensible grab for prices without taking on exposure if a summer rally appears, as Victor expects.
“You can remove some of that craziness,” he said.
Let’s hope he’s right about that summer rally.
