Risks of this Strategy
While usual short-crop price patterns suggest that prices will peak early, this may not be the case this year. Futures prices could peak after the October settlement period, as occurred in 1993 and 1995 (see here). This would result in hedging losses and lower incomes than would be the case had hedging not occurred.
Margin calls could occur if futures prices rise after setting the hedge. For example, an increase in corn price by $1/bu., something that is conceivable, would result in roughly a $140/acre margin call if 140 bu./acre are hedged. Margin calls due to rising prices could occur at any time between placing and lifting the hedge.
Harvest prices used to set crop insurance guarantees cannot exceed two times the projected price. This means that the 2012 harvest price for corn cannot exceed $11.36 ($5.68 x 2) and for soybeans cannot exceed $25.10 ($12.55 x 2). It is unlikely futures prices will be above these levels; however, settlement prices above those levels would cause crop insurance payments not to cover all of hedging losses.
The previous examples assume that the harvest price is the same as the futures price at which hedges are lifted. In practice, this will be difficult to do, as the settlement price is based on an average of October settlement prices. If multiple futures contracts are needed to implement the hedge, lifting those contracts throughout October would minimize difference between the lift prices in hedges and the crop insurance settlement price.
Basis could change from those used in the examples.
Variations of this Hedge
- The previous examples assume that the entire yield guarantee is hedged. A farmer could choose to hedge only a portion of the yield guarantee. For example, choosing to hedge 50% results in a price equaling half the current futures price and half the harvest price in October.
- Hedging could be accomplished in stages over the next month. For example, one-fourth could be hedged in each of the next four weeks, thereby providing more of an average price for placing the hedge.
- A farmer could accomplish this hedge through a combination of forward contracting and hedging using futures markets. Forward contracting could be done at a level where there is relative certainty that harvested bushels will cover the contracted amount.
- For producers who have already forward contracted or hedged 2012 production, the difference between the yield guarantee and amount hedged could still be hedged using the approach described above.
Producers may want to hedge all or a portion of their yield guarantees to take advantage of high prices that currently exist for harvest-time futures contracts. While prices could move higher, current prices would allow many farms to lock in profits, a situation that may exist later in the year.