Grain Marketing 101. University of Maryland Extension

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1 Grain Marketing 101 Jenny Rhodes Shannon Dill John Hall Extension Educators, Agriculture & Natural Resources Marketing terminology CBOT futures Basis Contracts Forward Contract Hedge to Arrive Basis Contract Futures Contract

2 Marketing terminology Options Put Calls Futures months Corn Soybeans Wheat Marketing terminology Bear Bearish Market Bull Bullish Market

3 Marketing terminology Web resources: Chicago Board of Trade after to 1/9/09 will be DTN Ag Data Ag Web Grain Marketing - MCE Marketing terminology Basis is the difference between a cash price and a futures price of a particular commodity on a given futures exchange. It is calculated as: Basis = cash price - futures price. Basis can be positive or negative.

4 Marketing terminology Contracts Forward Contract is a contract for the cash sale of grain at a specified price for future delivery. Hedge to Arrive Is a contract for the cash sale of grain which locks in the futures price at the date of contracting, the basis can be locked in later. Marketing terminology Contracts Basis Contract is an agreement between a producer and grain elevator (or feedlot) that specifies the cash price upon future delivery as a fixed amount in relation to the futures price (above or below), thus fixing the basis

5 Marketing terminology Futures Contract is a contract traded on a futures exchange for the delivery of a specified commodity at a future point in time. Most futures contracts do not result in physical delivery. An offsetting transaction usually occurs prior to delivery and any price differences are settled in cash. Marketing terminology Options Put is an option that gives the buyer the right, but not the obligation, to sell (go short) the underlying futures contract at the strike price on or before the expiration date. Calls Call Option is an option that gives the buyer the right, but not the obligation, to purchase (go long ) the underlying futures contract at the strike price on or before the option s expiration date.

6 Marketing terminology Futures month The months at which the futures trade Corn Harvest Dec Store - JFM Soybeans Harvest - Nov Store - JFM Wheat Harvest - July Bear Marketing terminology is a person who expects lower prices. Bearish Market is a market in which prices are declining. Bull is a person who expects higher prices. Bullish Market is a market in which prices are increasing.

7 Marketing tools Using Crop Insurance Crop Budgets Need to know cost of production Overall By farm By field Need to know break-even price you must receive Marketing tools Traditional market trends Market highs usually occur January to May Market volatility during growing time May need upside potential

8 Marketing tools Marketing tools Fixed price tools Forward Contracts Hedge to Arrives Futures contracts Minimum price tools PUT option setting a price floor CALL option upside potential Basis Cash price = Futures Price Basis Basis continues to change! Need to recognize good basis New processing plants are adding a new level of volatility to basis, particularly in the corn belt - this will affect the East Coast too. Keep up with the changes!

9 Sep Maryland Lower Eastern Shore Nearby Corn Basis, Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Avg Nearby Basis = Cash Price Nearby Corn Futures Source: Maryland Grain and Livestock Report, Maryland Department of Agriculture Maryland Lower Eastern Shore Nearby Soybean Basis, Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Avg Nearby Basis = Cash Price Nearby Soybean Futures Source: Maryland Grain and Livestock Report, Maryland Department of Agriculture

10 CBOT December Corn Futures, years (78%) the market declined 4 years (22%) the market improved 7 years the market declined more than 40 cents! Year Average 1-May Oct Change (0.42) 0.01 (0.41) 0.00 (0.44) 0.48 (0.44) (0.20) (0.58) (0.26) (0.63) (0.16) 0.36 (0.13) (1.11) (0.21) (0.04) (0.10) (0.24) Chicago December Corn Futures, average Don t forget to sell something! cents p er bushel Jan 1-Feb 1-Mar 1-Ap r 1-May 1-Jun 1-Jul But remember your minimum price. approximate dates 1-Aug 1-Sep 1-Oct 1-Nov 1-Dec

11 Contract 1-May 1-Oct Change (0.51) CBOT November Soybean Futures, (0.20) (0.72) 0.22 (0.90) years (67%) the market declined (0.08) (0.76) (1.02) 6 years (33%) the market improved (0.33) (0.90) years the market declined more than 50 cents! (2.10) (0.49) (0.81) Average (0.21) 620 Chicago November Soybean Futures, average 615 Don t forget to sell something! cents p er bushel Jan 1-Feb 1-Mar 1-Ap r 1-May 1-Jun 1-Jul 1-Aug 1-Sep 1-Oct 1-Nov But remember your minimum price. approximate dates

12 Year 1-May 1-Jul Change (0.15) (0.16) Chicago July Soft Red Winter Wheat, years (67%) the market declined (0.13) (0.09) (0.23) 0.87 (1.13) (1.03) (0.28) (0.22) 6 years (33%) the market improved (0.05) (0.31) (0.60) Average (0.12) 345 Chicago July Wheat Futures, average cents per bushel Aug 1-Sep 1-Oct Don t forget to sell something early! 1-Nov 1-Dec 1-Jan 1-Feb 1-Mar 1-Apr 1-May 1-Jun 1-Jul But remember your minimum price. approximate dates

13 Pre-Harvest Pricing The 18 year seasonal price history is compelling, but consider two more reasons why pre-harvest sales are important 1. Strong seasonal tendency 2. The sale is made at a price that works for me! Pricing Tools Fixed-price tools Forward contract Sell futures Futures fixed (HTA) Minimum-price tools Forward contract and buy a call option Buy a put option Minimum price tool offered by local elevator (?)

14 Pricing Tools Fixed-price tools +Final price is known (or nearly known) No upside potential if prices go higher Minimum-price tools (Options) +Upside potential High cost makes it difficult to use in early sales (which are likely lower price sales) Fixed-Price Tools Forward contract +Exact price is known (basis is fixed) +Contract can be for any bushel amount, not just 5,000 bushel increments +No brokerage fee, margin accounts or margin calls Ends in delivery Sometimes difficult to get a fair basis

15 Fixed-Price Tools- Forward Contract Buyer: Nagel Farm Service, Inc Date: 06/05/08 P. O. Box 340 Contract: Preston, MD Account # RHODEJ Seller: Jennifer L. Rhodes 180 Chestnut Vale Farm Lane Centreville, MD We confirm PURCHASE from you as follows: Commodity Quantity Price Delivery From Price Basis Loc Buyer #2 Corn 5, /01/09-03/31/09 Delivered 001 Chad Remarks: #2 Corn Delivered to Bridgeville or Seaford J/F/M Fixed-Price Tools- Basis Contract Buyer: Nagel Farm Service, Inc Date: 11/18/08 P. O. Box 340 Contract: Preston, MD Account # RHODEJ Seller: Jennifer L. Rhodes 180 Chestnut Vale Farm Lane Centreville, MD We confirm PURCHASE from you as follows: Commodity Quantity Basis Option Delivery From Price Basis Loc Buyer #2 Corn 5, MAR09 03/01/09-03/31/09 Dlvd: Wye Mills 001 Chad Remarks: 08 Corn Harvest BASIS CONTRACTS MUST BE PRICED OR ROLLED DURING CBOT TRADING HOURS PRIOR TO FIRST NOTICE DAY OF THE CORRESPONDING FUTURES CONTRACT ***********************************************************************

16 Fixed-Price Tools Sell futures (hedging) + Average price is usually higher compared to forward contracting + Not locked into delivery, can be rolled into a storage hedge to capture market carry after harvest Contract in units of 5,000 bushels Requires margin account and must provide margin money as market fluctuates (margin calls) Must buy futures to exit the position Basis risk Fixed-Price Tools Sell futures What is my expected price? futures price (when sold) + expected harvest basis brokerage fees = expected price $ (-0.30) $7.89

17 Fixed-Price Tools Hedge-to-Arrive contract + Just like selling futures except you work with local elevator + Contract can usually be for any bushel amount, not just 5,000 bushel increments + No brokerage fee, margin accounts or margin calls + Most elevators let you lock-in the basis sometime during the contract + May be rolled into storage hedge (terms differ) Pay a fee (1-5 cents per bushel) Basis risk Locked into local elevator delivery Hedge to Arrive Must recognize basis movement Is it a good basis?

18 Costs of tools A. Forward Contract Bushels * (Futures Price + Basis) Cost? No cost Must guarantee bushels with the elevator Fixed-Price Tools Sell forward contract What is my expected price? Contract price = expected price $2.51 = $2.51 What happens if prices go up? Go down?

19 Fixed-Price Tools B. Futures fixed contract (Hedge-to- Arrive) What is my expected price? Contract price + basis = expected price $ = $2.51 What happens if prices go up? Go down? Fixed-Price Tools B. Futures fixed contract (Hedge-to- Arrive) What is my expected price? Contract price + basis = expected price $ = $2.51 What happens if basis changes to +.06 $ = $2.57

20 Fixed-Price Tools B. Futures fixed contract (Hedge-to- Arrive) What is my expected price? Contract price + basis = expected price $ $2.51 = What happens if basis changes to -.06 $ = $2.45 Options Trade premium (paper), not bushels Consider Crop insurance as floor Options can be costly Puts Use to set floor on remainder of crop CALL options can offer upside potential on fixed price contracts You can enter and exit anytime during contract Know when to hold them and when to fold them

21 Terminology Strike Price The indexed values that are for sale At the money At the Futures price In the Money Near the Futures Price Out of the money Away from the Futures price Premium The cost / value that is being traded Options Advantage of Options No production risk Can get in and out with a phone call No margin calls Disadvantages: They can be expensive Price must move more than premium

22 Costs of tools CALL options The right to buy Futures Prices are $2.50 Buy a option with a $2.50 strike price If prices go to $2.70 and you have the right to buy at $2.50, is that value? If prices go to $2.30 and you have the right to buy at $2.50, is that value? Use for upward price potential CALL- Prices go up Futures Strike Option Price Price Premium Value $ $ Cash in 0.27 (.02) = = +$0.12 per bushel

23 CALL- Prices go down Futures Strike Option Price Price Premium Value $ $150 (-$500) Cash in 0.03 (.02) = = - $0.12 PER BUSHEL If they expire worthless Commission $ = -$0.15 per bushel When to use Call Options To cover Forward contracts when there is an need for upward price movement During volatile times in the summer To extend the marketing year Sell harvest Buy a March Call

24 Calls.. Strike Fwd Contract & Buy Price Premium Call, Min Local Price Costs of tools PUT options The right to sell Futures Prices are $2.50 Buy a option with a $2.50 strike price If prices go to $2.30 and you have the right to sell at $2.50, is that value? If prices go to $2.70 and you have the right to sell at $2.50, is that value? Use to set price floor

25 PUT Formula Strike Price -Premium -Commission and Interest Minimum Effective Selling Price When to use PUT s To cover the bushels we cannot forward contract Put options do not have production risk In our game, we have 19,000 bushels that are unprotected. Consider a PUT when prices are high

26 PUT- Prices go down Futures Strike Option Price Price Premium Value $ $1500 Cash in 0.30 (.02) = = +.15 PER BUSHEL PUT- Prices go up Futures Strike Option Price Price Premium Value $ $ (-$450) Cash in 0.04 (.02) = = -$0.11 per bushel If they expire worthless Commission ( = -$0.15 per bushel

27 Puts Strike Buy Put, Min Price Premium Local Price Minimum-Price Tools Forward contract AND buy a call option Soybean example: Forward contract price is $7.80, Nov futures trading at $8.20, a call at $8.20 strike price has a 65 cent premium What is the minimum price? forward contract price call premium brokerage fee = minimum price $ = $7.14

28 Quiz Time! To use options profitably, which of the following three aspects of price movement must you forecast correctly? A. Price direction B. The magnitude of the price move C. The timing of the price move D. All of the above Quiz Time! To use options profitably, which of the following three aspects of price movement must you forecast correctly? A. Price direction B. The magnitude of the price move C. The timing of the price move D. All of the above

29 Minimum-Price Tools Buy a put option Corn example: Dec futures trading at $3.90, a put at $3.90 strike price has 40 cent premium What is the minimum price? put strike price + expected basis - put premium - brokerage fee = minimum price $ (-0.00) = $3.49 Minimum-Price Tools So what is the difference between buying a put option VS. forward contracting and buying a call option? They both set a minimum price Do you want to fix the basis? You have to calculate which method offers the best minimum price at any given time See your tax advisor about call option losses

30 Marketing is Important! The average farm earns cents per bushel (including gov t payments). Just 10 cents more per bushel could increase net income by 33-50%! Great marketing is not finding the high price. It s finding an extra cents per bushel with a solid plan that avoids mistakes. What is a Marketing Plan? A marketing plan is a proactive strategy to price your grain that considers your financial goals, cash flow needs, price objectives, storage capacity, crop insurance coverage, anticipated production, and appetite for risk Proactive, not reactive, not overactive

31 Why do I need a Marketing Plan? Fear and greed are powerful emotions - they will affect your decisions. A solid plan is the only effective weapon against these emotions Plan your trades, trade your plan Decision Dates How do they work? If I reach a decision date before my pricing target is met, I will price the grain (if prices are above my minimum pricing threshold). Decision dates are needed to make it a real plan for action Crop insurance and/or options allow us to forward price with confidence What s so special about the March to May period in pre-harvest pricing?

32 Tillman Farm Pre-Harvest Corn Marketing Plan Objective: Buy crop insurance to protect my production risk and have 75% of my anticipated corn crop (based on APH yield) priced by early June. Price 10,000 bushels at $3.00 cash price ($3.00 Dec. futures) using forward contract/futures hedge/futures fixed contract. Price 10,000 bushels at $3.15c/3.15f, or by Mar 7, using a fixed-price contract. Price 10,000 bushels at $3.30c/3.30f, or by Apr 4, using a fixed-price contract. Price 15,000 bushels at $3.45c/3.45f, or by Apr 15, consider options/trend system. Price 10,000 bushels at $3.60c/3.60f, or by May 5, consider options/trend system. Price 10,000 bushels at $3.75c/3.75f, or by June 3, consider options/trend system. Plan starts on November 1, Earlier sales will be made at a 30 cent premium to price targets noted above and will be limited to 30,000 bushels. Ignore decision dates and make no sale if prices are lower than $3.00 local cash price/$3.00 December futures. Exit all options positions by mid-september (1) Pricing targets Tillman Farm (2) Decision dates Pre-Harvest Corn Marketing Plan Objective: Buy crop insurance to protect my production risk and have 75% of my anticipated corn crop (based on APH yield) priced by early June. Price 10,000 bushels at $3.00 cash price ($3.00 Dec. futures) using forward contract/futures hedge/futures fixed contract. Price 10,000 bushels at $3.15c/3.15f, or by Mar 7, using a fixed-price contract. Price 10,000 bushels at $3.30c/3.30f, or by Apr 4, using a fixed-price contract. Price 15,000 bushels at $3.45c/3.45f, or by Apr 15, consider options/trend system. Price 10,000 bushels at $3.60c/3.60f, or by May 5, consider options/trend system. Price 10,000 bushels at $3.75c/3.75f, or by June 3, consider options/trend system. Plan starts on November 1, Earlier sales will be made at a 30 cent premium to price targets noted above and will be limited to 30,000 bushels. Ignore decision dates and make no sale if prices are lower than $3.00 local cash price/$3.00 December futures. Exit all options positions by mid-september 2008.

33 Tillman Farm Pre-Harvest Corn Marketing Plan Objective: Buy crop insurance to protect my production risk and have 75% of my anticipated corn crop (based on APH yield) priced by early June. Price 10,000 bushels at $3.00 cash price ($3.00 Dec. futures) using forward Why March-April-May? contract/futures hedge/futures fixed contract. Price 10,000 bushels at $3.15c/3.15f, or by Mar 7, using a fixed-price contract. Price 10,000 bushels at $3.30c/3.30f, or by Apr 4, using a fixed-price contract. Price 15,000 bushels at $3.45c/3.45f, or by Apr 15, consider options/trend system. Price 10,000 bushels at $3.60c/3.60f, or by May 5, consider options/trend system. Price 10,000 bushels at $3.75c/3.75f, or by June 3, consider options/trend system. Plan starts on November 1, Earlier sales will be made at a 30 cent premium to price targets noted above and will be limited to 30,000 bushels. Ignore decision dates and make no sale if prices are lower than $3.00 local cash price/$3.00 December futures. Exit all options positions by mid-september Tillman Farm Pre-Harvest Corn Marketing Plan Objective: Buy crop insurance to protect my production risk and have 75% of my anticipated corn crop (based on APH yield) priced by early June. Price 10,000 bushels at $3.00 cash price ($3.00 Dec. futures) using forward contract/futures hedge/futures fixed contract. Price 10,000 bushels at $3.15c/3.15f, or by Mar 7, using a fixed-price contract. Price 10,000 bushels at $3.30c/3.30f, or by Apr 4, using a fixed-price contract. Price 15,000 bushels at $3.45c/3.45f, or by Apr 15, consider options/trend system. Price 10,000 bushels at $3.60c/3.60f, or by May 5, consider options/trend system. Price 10,000 bushels at $3.75c/3.75f, or by June 3, consider options/trend system. Plan starts on November 1, Earlier sales will be made at a 30 cent premium to price targets noted above and will be limited to 30,000 bushels. Ignore decision dates and make no sale if prices are lower than $3.00 local cash price/$3.00 December futures. (3) Pricing tools Exit all options positions by mid-september 2008.

34 Tillman Farm Pre-Harvest Corn Marketing Plan Objective: Buy crop insurance to protect my production risk and have 75% of my anticipated corn crop (based on APH yield) priced by early June. Price 10,000 bushels at $3.00 cash price ($3.00 Dec. futures) using forward contract/futures hedge/futures fixed contract. Price 10,000 bushels at $3.15c/3.15f, or by Mar 7, using a fixed-price contract. Price 10,000 bushels at $3.30c/3.30f, or by Apr 4, using a fixed-price contract. Price 15,000 bushels at $3.45c/3.45f, or by Apr 15, consider options/trend system. Price 10,000 bushels at $3.60c/3.60f, or by May 5, consider options/trend system. Price 10,000 bushels at $3.75c/3.75f, or by June 3, consider options/trend system. Plan starts on November 1, Earlier sales will be made at a 30 cent premium to price targets noted above and will be limited to 30,000 bushels. Ignore decision dates and make no sale if prices are lower than $3.00 local cash price/$3.00 December futures. Exit all options positions by mid-september (1) Pricing targets (2) Decision dates (3) Pricing tools References Chicago Board of Trade Winning the Game, University of Minnesota DTN

35 Thank you Questions Contact information:

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