Most producers see a handful of raging bull markets in their farming career.
Grain supplies tighten for some reasons such as weather or demand, sparking a rally that builds into a frenzy in the futures market sends grain prices spiking into the stratosphere.
Such rallies can add to farmers’ incomes, but rarely do producers enjoy the kind of windfalls that commodity speculators receive.
The spikes usually last only a few weeks and there is no guarantee that the farmer will have grain to sell into the rally.
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Some experts, such as commodities guru Jim Rogers, think there is potential for such a spike in the next 10 years, given grain stocks that are tight by historical standards, potential demand from China and the always present danger of bad weather.
All this prompts the question: is there an affordable way to use market tools to capture unexpected price spikes?
One strategy would be to buy far out of the money call options and sit back with fingers crossed to wait for the hot rally.
As you’ll read, marketing experts don’t recommend this, but here is how it could work.
A call option allows an owner to buy a certain amount of a stock or commodity for a certain price up until a certain date. “Out of the money” means that the purchase price is above the price today.
Far out of the money calls are cheap because option writers doubt they will be executed. Because they are cheap, a person could buy enough to cover a lot of grain and then wait to see if something triggers a price spike before their options expire.
But while the options are cheap, you would have to constantly buy them to be prepared for that rare price spike.
Farm marketing advisers say few farmers have the money or temperament to make the strategy work.
“Where’s the cash flow?” said Errol Anderson of Pro Market Communications in Calgary. “You need to spend money to do that.”
Added Ken Ball of Union Securities in Winnipeg: “That’s fairly expensive if your timing is wrong or if the event takes a long time to come around.”
It also requires an unusual character willing to gamble money in the hope of striking it big.
“The time to be buying the calls is when it seems like you shouldn’t be,” said Ball.
“It’s when it seems like you’d be throwing your money away. You can invest in soybean call options, but if South America has an average crop, that money may be gone. That may make a frustrating year on the Prairies more frustrating.”
Anderson said a call options strategy might work, if done perfectly, over the long run.
“Once a decade, incredible profits are made,” he said.
But if not done perfectly, the great year can become another bad year for an amateur.
Because the strategy is so risky, Anderson thinks farmers shouldn’t speculate with call options.
He thinks farmers should focus on their future crop and first try to lock in profitable prices for about a third of it.
Next, they should take advantage of normal market rallies and spikes by buying puts as the market goes higher. In a spike environment, scaling in puts will hedge future cash sales and become valuable if the spike collapses, which is likely.
While price spikes tend to peak and collapse, slumps are usually shaped like a U, staying low for a long time, allowing the grower to sell out his put position and realize his profit.
Ball also thinks farmers should not speculate on price spikes, but be ready to use them to price future crops.
“Let them happen and start selling next year’s crop,” he said. “If you’ve got crop in the bin, sell it into the market.”
Ball said farmers might want to make up for today’s poor cash sales by using calls this winter, but he thinks they should focus on next year’s crop, so they are set for a market rally with new rather than old production.
Few farmers will make the windfall profits that deep-pocketed speculators can make from a rare commodities spike, but Anderson and Ball think a more cautious hedging strategy can achieve significant gains without the costs. For a low-margin, high-risk business like farming, that’s probably a better bet.
