Huge market rallies in late June saw December 2012 corn jump from $5.05/bu. to $6.44 within two weeks. They swelled 40¢ on June 25 – hello limit-up – on the back of Corn Belt drought fears. They blew through $6.20 on June 26 and $6.40 on the 27th. And by mid-July, the price-surging weather market shot Dec corn to $7.80.
But price volatility rules. Last spring, Chad Hart, Iowa State University Extension economist, said corn prices could range from $3-8. How can one be insulated against such volatility? How can a grower’s bullish attitude keep him from suffering a $1 dip in prices when unforeseen factors suddenly pound the markets?
“I would be looking to market another piece of my crop now,” Hart says, in light of summer market surges. “The rally has created some favorable margins that can be locked in. However, I would not forward contract any more than I have insured (through Revenue Protection insurance). The rally also provides an opportunity to use put options to create price floors (if I don’t want to sell right now).”
Matthew Diersen, South Dakota State University agricultural economics professor, says many producers “need these rallies to obtain a more profitable price level. Selective hedging, pricing a portion when the price is good enough, continues to be a sound strategy.”
Getting more crops marketed may help you sleep better. For example, if your corn yield is 175 bu. and you contracted 20% of your 1,000 acres of production at $6.44 (the price June 27), that’s about $50,000 in added gross return above the $5.05 price just two weeks earlier, depending upon your basis. If you waited until the price swelled to $7.80, that’s an added return of nearly $100,000 (the $2.75 higher price x 35,000 bu.).
But what if you’re still bullish? You just know $9 is over the horizon. Consider buying an out-of-the-money put to set a floor and leave you open to the upside. For example, when the $7.80 futures price was hit, a $6.80 put cost about 22¢/bu., putting the floor at $6.58 ($6.80-22¢). But you could still take advantage of rallies. The $6.80 wasn’t $7.80, but it was more than $1.50 better than it was in mid-June and $9 corn was still for the taking.
Diersen says “synthetic puts” can also help offset high premiums. “That’s where a producer would sell a futures contract and buy an out-of-the-money call option at the same time,” he says. “An option with a strike price $1-2 above the futures price will be less expensive than an at-the-money option. A synthetic put strategy like this gives a floor price closer to the futures level compared to a traditional put strategy.”
Hart adds that if dry weather creates an even stronger bullish attitude, consider using calls on bushels already sold. “They would allow me to recapture upside potential and limit the downside to the call option premium,” he says. “Since I’m doing it on already sold bushels, I know my price floor with those bushels (the cash forward sale price minus the call option premium).”
He encourages growers to use market swings to their favor. “When the market is up, that means the cost of putting in a price floor through puts is lower,” he says. “When the market is down, that provides a opportunity to purchase that call so that if prices rise again you can benefit.
“Option premiums reflect the volatility in the market. So yes, higher volatility implies higher option premiums. But that volatility can also provide opportunities.”