Production vs Marketing

[errolanderson]

Hopperbin . . . some growers started
placing March Chicago wheat put option
bear spreads last fall. Some placed a
$7.50 to $6.50 spread on, some did a $7
to $6 bear spread and so on. But these
spreads have since expired but provided
gains from a drop in the market through
winter. Positions allowed growers 3 to 4
months of downward price protection.
Some have now positioned themselves with
July to October bear spreads for further
protection. The problem with wheat
spreads is they can be expensive and
economically a grower can only go out 3
or 4 months affordably. This is a
problem with wheat. Corn is more
flexible and less expensive. Growers can
protect themselves up to a year ahead in
corn for reasonable money.

For the growers that stuck to a
disciplined marketing plan with wheat,
it has been beneficial as higher fall
prices have been guarded.

But like cottonpicken stated, the wheat
market looks like its bottoming right
now. A grower with bear spreads might
decide to jump ship. But from a farm
management point of view, it may be good
to hold this protection as India is now
exporting and the Americans appear to
have a solid start to their winter
wheat crop.

Some growers have just shorted the
futures ion Minneapolis and Chicago, but
you have to be able to stomach margin
calls from your broker. It's just a fact
of life in the hedging world.

Hope this helps . . . .
Errol

[Hopperbin]

Can you please define bear spread?

[errolanderson]

Hopper . . . a put option bear spread is
when a put option is purchased and a put
option is sold as a spread to protect a
drop in price. You can also do a call
option bull spread ( buy a call and sell
a call) to create an upward window.

Here's example of call option bull
spread that some growers used to replace
feed barley/feed wheat sales.

Example: sell cash barley at $4.50/bu
farmgate. But want to take advantage of
a weather related rally should it occur
through summer. Some growers have
purchased a Dec corn $6 to $7/call bull
spread (bought the $6 call and sold the
$7 call). Lets say a Dec corn $6 call is
worth 60 cents/bu and a $7 call is worth
30 cents/bu. A grower wanting a $1/bu
upward window would pay 30 cents/bu in
this example. (60 cent $6 call - 30 cent
$7 call. Remember if you sell a call,
this premium is credited to your
account. The bottomline is; grower is
risking 30 cents/bu to potentially make
$1/bu, should December corn expire above
$7/bu. But lets say, corn drops, the 30
cent bull spread will expire worthless.
Why do growers use this type of
strategy? 1. no risk of margin call. 2.
Option spreads are less expensive than
just purchasing an at-the-money call or
put option. What are the disadvantages?
Corn example . . . lets say corn blows
to $8/bu. Your 30 cent premium maxes out
at $7/bu for max trade value of $1/bu.
You would not gain any more than the
$1/bu - 30 cent premium = 70 cents/bu
total gain, even though corn blew to
$8/bu.

Lets look at wheat . . . rule of thumb,
an at-the-money Chicago wheat put option
4 months forward from now is worth about
70 cents/bu. (At home, don't see actual
quotes, so making example up) . . .Buy a
July Wheat $6.50 put and sell a July
wheat $5.80 put . . . for a difference
of 25 cents/bu. In this example, grower
risks 25 cents/bu to guard 70 cent/bu of
market downside. You can build whatever
spread window you want, depending on how
much money you want to place at risk.

Now the question begs . . . why not just
buy a put or a call option. Forget about
these silly spreads. Answer:The spreads
give you a better starting point for
less money. For wheat, buying an at the
money wheat put option 6 months out
costs an arm 'n a leg. And if you cut
your premium (purchase out-of-the-money
put), your price protection and option
quality drops significantly. That's why
option spreads make more sense for wheat
(in my opinion).

My apologies for a windy response. A
beer, chalk board and grump about the
Oilers and Flames would be easier than
trying to describe on-line.

My feeling is; understanding these
strategies is just another tool for your
marketing toolbox, whether you ever use
these strategies or not in your farm
marketing plan.

Hopper, I tried . . .

Errol

[wd9]

But Errol, while for every good decision
there is a bad one. Like Vegas, when
someone comes back, they always won.

Anyone compare cash selling to doing
market gymnastics after all the brokers,
gains and losses from all the decisions
over an extended period, ie at least 5
years?

[errolanderson]

wd9 - you are right, there are years
when you can place your hands in your
pocket and come out smelling like a rose
marketing-wise. This is one of those
years for canola and feed grains, but
certainly not wheat. No marketing has
cost wheat growers big-time.

Marketing is definately a art, rather
than a science and everyone's marketing
program and tolerance is different. We
each have different risk tolerances for
our operations.

Because of so many variables, it would
be very difficult to do a clear cut
study on the effectiveness of marketing
as it is different for everyone. My view
is you have to feel comfortable in you
own skin. If you don't want to forward
price, use a broker broker etc, don't.
And you may do fine some years. But in
my opinion, marketing is at least 30% of
your profitiablity, maybe higher.

I have seen cattle feeders make money on
a pen only because they owned protective
put options. The feeding side was a
wreck.

My view; don't let your marketing guard
down. If everyone would market with a
plan, there may be a lot less need for
government subsidies. You won't sell at
the top of any market without luck, but
you will make profit on every truckload
of grain.

Errol

[TOM4CWB]

Errol,

On the wheat... think again.

Grade is a problem... ergot, frost...

Basis killed great futures lockins.

Lock in the first 1/3 after seeding if Act of God; is safe... otherwise big risk on drought...

It is all a big average in the end... I don't know anyone who sells everything the same day.

Cheers!

[wd9]

Errol, i would agree, sort of. Again,
after allthe averages are calculated out
and the difference after a few years, all
i'm saying is it worth the bother and the
headache because this thread poses that
very question, prod vs marketing.