Chad Hart Assoc. Professor of Economics, Iowa State University
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Transcript of Chad Hart Assoc. Professor of Economics, Iowa State University
Chad Hart Assoc. Professor
of Economics, Iowa State University
Steve JohnsonISU Extension
Farm Management Specialist
Ed Kordick Commodity Services
Manager,Iowa Farm Bureau
Presentation Objectives:
• Education on basic marketing tools
• Introduction to the Marketing Tools Workbook
• Invitation to continue learning by experience with Iowa Commodity Challenge after this session.
Marketing Tools Workbook
Crop Marketing
• Unpredictable events, emotions, volatility• Back to the basics: know the tools,
have revenue perspective, realistic goals • Price is not an adequate measure of success
• How do you define success? hitting revenue goals, reducing risk, . . . . . .
Decide what success means to you
Futures and Basis Movement
Futures Hedging
• Hedging: taking an equal and opposite position in the futures market than you have in the cash market.
• When a farmer hedges they take an action now in the futures market that they will take later in the cash market. – If the farmer will sell bushels later in the cash
market, the bushels can be sold now in the futures market to protect downside price risk.
Why Hedging Works:5
Hedging Example
DATE CASH FUTURES BASIS
Results
Start date
End date
Hedging Example
DATE CASH FUTURES BASIS
Results
In this presentation, T diagrams are used in examples to track three market components: Cash Futures Basisover the time period that the hedge is in place.
• The difference between the cash price and futures price. Many factors influence basis:
local supply/demand, etc.
• The calculation for basis is: Cash Price – Futures Price = Basis $4.80 – $5.10 = - $0.30
$14.20 – $14.70 = - $0.50
Basis
Example futures hedge story
• It’s November: the goal is to sell 5000 bushels of cash corn in late Feb. at $4.30.
• Estimated basis for late February is -30¢ (cash under March futures).
• March corn futures are sold at $4.60
• Let’s see what happens if the market goes either way !
Hedging Example (market lower)
DATE CASH FUTURES BASIS
Sell 1 March Corn
@ $4.60
Buy 1 March Corn
@ $4.15
Late February
November
Results
Goal: $4.30 Cash Corn
Sell Cash Corn
@ $3.85
- 45¢
Estimated: - 30¢
0.00+ 45¢
Actual: - 30¢
6
Hedging Example (market lower)
Net Hedge (without commissions and interest cost)
1.Original futures less actual basis = net hedge $4.60 – 0.30 = $4.302. Cash sale to buyer +/– futures gain/loss = net hedge $3.85 + 0.45 = $4.30
Hedging Example (market higher)
DATE CASH FUTURES BASIS
Sell 1 March Corn
@ $4.60
Buy 1 March Corn
@ $5.00
Late February
November
Results
Goal: $4.30 Cash Corn
Sell Cash Corn
@ $4.70
+ 40¢
Estimated: - 30¢
0.00- 40¢
Actual: - 30¢
7
Hedging Example (market higher)
Net Hedge (without commissions and interest cost)
1.Original futures less actual basis = net hedge $4.60 – 0.30 = $4.302. Cash sale to buyer +/– futures gain/loss = net hedge $4.70 – 0.40 = $4.30
Example futures hedge story
• Story begins the same: November, the goal is to sell 5000 bu. cash corn at $4.30.
• Estimated basis for late February is -30¢,
March corn futures are sold at $4.60
• Let’s see what happens if basis is different than expected !
Hedging Example (market lower)
DATE CASH FUTURES BASIS
Sell 1 March Corn
@ $4.60
Buy 1 March Corn
@ $4.10
Late February
November
Results
Goal: $4.30 Cash
Corn
Sell Cash Corn @
$4.00
- 30¢
Estimated: - 30¢
+ 20¢+ 50¢
Actual: - 10¢
9
Hedging Example (market lower)
Net Hedge (without commissions and interest cost)
1.Original futures less actual basis = net hedge $4.60 – 0.10 = $4.502. Cash sale to buyer +/– futures gain/loss = net hedge $4.00 + 0.50 = $4.50
Hedging Example (market higher)
DATE CASH FUTURES BASIS
Sell 1 March Corn
@ $4.60
Buy 1 March Corn
@ $5.20
Late February
November
Results
Goal: $4.30 Cash
Corn
Sell Cash Corn
@ $4.80
+ 50¢
Estimated: - 30¢
- 10¢- 60¢
Actual: - 40¢
10
Net Hedge (without commissions and interest cost)
1.Original futures less actual basis = net hedge $4.60 – 0.40 = $4.202. Cash sale to buyer +/– futures gain/loss = net hedge $4.80 – 0.60 = $4.20
Hedging Example (market higher)
Key points:
• Price does not define marketing success, hitting revenue goals, reducing risk, . . . . . .
• The cash market, futures market and basis can be tracked in futures hedges
• A futures hedge works in up & down markets• Basis is key to result of futures hedge:
Stronger basis than expected = Higher price Weaker basis than expected = Lower price
Carry and Cost of Ownership
Defined: The difference in price between the nearby contact and the more distant delivery months (deferred). Compare the carry offered by the market to the costs of storing grain for the various delivery months.
Carry Market
In a year like 2012, the limited supply has reduced demand. There is little to no carry in the futures markets. The nearby futures contract is actually higher than the deferred futures. The market provides little incentive for storing the crop.
Inverted Market
Corn Futures Inverse Soybean Futures Inverse
Source: www.cmegroup.com
Example Corn Futures
Date: Oct. 16th, 2013
$4.43Dec.
$4.55Mar.
$4.63May
$4.71July
Source: www.cmegroup.com
Example Soybean Futures
Date: Oct. 16th, 2013
$12.75Jan.
$12.63Mar.
$12.49May$12.47July
Corn On-Farm: Monthly Charge = 3¢/bushel Commercial: Monthly Charge = 6¢/bushel
Cost of Ownership
Soybeans On-Farm: Monthly Charge = 4¢/bushel Commercial: Monthly Charge = 6¢/bushel
Key points:
• Compare the carry offered by the market to the costs of storing grain for the various delivery months
• The Cost of Ownership will accrue Commercially for both corn and soybeans at 6¢/bushel/month.
Forward Cash Contracts
Forward Cash Contract
Defined: An agreement between a buyer and seller covering a quantity and quality of grain to be delivered at a specified location and time in exchange for a specific price.
Example: 5,000 bushel of #2 yellow corn delivered
to Local Co-op the last half of February The cash price at delivery will be -$.40
under the March corn futures contract that closed at $4.60/bu.
14
Forward Cash Contract
A Forward Cash Contract is a binding transaction between the seller and buyer for a later delivery date. Conditions are set including the quantity of bushels, the quality, delivery time and cash price.
Quantity Quality Delivery Location Cash
Price
5,000 bu. #2 Yellow Corn
Last Half February
Local
Co-op
$4.20
/bu
Forward Cash Contract
Forward Cash Contracts are widely used and:
Set the cash price and delivery terms Are available both before and after
harvest Don’t require margin deposits or
premiums.
DisadvantagesPenalties if cannot deliver the contracted amountLocked in price (can’t go higher)Often receive a wider basis.
Forward Cash Contract
AdvantagesNo margin deposit requiredLock in price and delivery terms
Hedge-to-Arrive Contract
Hedge-to-Arrive (HTA) Contracts are similar to Forward Cash Contracts. The binding transaction sets the:
Delivery Date and Location Amount of Bushels to Deliver Quality of those Bushels The Basis is typically not set when the
transaction is initiated, however the Futures Price is established. The Seller sets the Basis prior to Delivery.
Hedge-to-Arrive Contract
Similar to a Forward Cash Contract, an HTA Contract is a binding transaction between the seller and buyer for a later delivery date. Conditions are set including the quantity of bushels, the quality, delivery time but the cash price is not known until the Basis is set.
Quantity Quality Delivery Location Cash
Price
5,000 bu. #2 Yellow Corn
Last Half February
Local
Co-op
?
Margin Flows
DisadvantageMust understand margin callsCommissionsBasis risk
Futures ContractsAdvantages
Flexibility, ease of entry and exitReduces price riskCan improve basis
Margin money is “good faith” money that is deposited into the futures account.
Performance bond Money that covers changes in the value
of the contract position Minimum margins are set by the
exchange Additional margin can be collected if the
futures contract is losing value for the user
Margin Account
There are two key margin levels: Initial margin Maintenance margin
Key Margin Levels
The initial margin is the amount you have to deposit to participate in the futures market.
The maintenance margin is the amount you have to keep as a minimum balance.
Key Margin Levels
Corn Soybeans
Initial $1,650 $3,300
Maintenance $1,500 $3,000$ per contract
Let’s go through an example
Margin Example
Sold 1 corn futures contract at $5.00 per bushel17
Day Price Change in Value
Computed Balance
Margin Call
Ending Balance
1 $5.00 $1,650
2 $5.10 –$ 500 $1,150 $ 500 $1,650
3 $5.30 –$1,000 $ 650 $1,000 $1,650
4 $4.90 +$2,000 $3,650 $3,650
5 $5.00 –$ 500 $3,863 $3,150
Basic Options, Intrinsic and Time Value
An option is the right, but not the obligation, to buy or sell a futures contract.
Options Contracts
Farmers can buy and sell options. When you buy an option, you get the right.When you sell an option, you face the obligation.
Options are tied to specific futures contracts.
The strike price is the price in the option at which you may buy (or sell) futures contracts.
Types of OptionsThere are two types of options:
PutsCalls
A put option gives you the right to sell futures.Put options are often used to set price floors.
A call option gives you the right to buy futures.Call options are often used to replace cash bushels.
ExamplesLet’s say you buy a $4.50 put on July corn futures.
That put gives you the right to sell July corn futures for $4.50 per bushel.
If you had bought a $4.50 call, that would give you the right to buy July corn futures for $4.50 per bushel.
Example Put
Put options pay out when futures prices fall. Here’s the payout schedule for a $4.50 put on July 2014 corn.
Example Call
Call options pay out when futures prices rise. Here’s the payout schedule for a $4.50 call on July 2014 corn.
Premium vs. Margin
5.00
5.50
6.00
6.50
7.00
7.50
8.00
8.50
3/3/
2008
3/10
/200
8
3/17
/200
8
3/24
/200
8
3/31
/200
8
4/7/
2008
4/14
/200
8
4/21
/200
8
4/28
/200
8
5/5/
2008
5/12
/200
8
5/19
/200
8
5/26
/200
8
6/2/
2008
6/9/
2008
6/16
/200
8
6/23
/200
8
6/30
/200
8
$ p
er b
ush
el
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
$ p
er c
on
trac
t
Futures Cumul. Margin Calls Option Cost
22
Options PremiumsCan be divided into two sections:
Intrinsic value What is the option worth today?
Time valueHow much time is left on the option?
Intrinsic value depends on the futures price and the strike price of the option.
Time value depends on the length of time in the option and the price volatility in the market.
Example
Day Futures Price
Option Premium
Intrinsic Value
Time Value
1 $12.00 $0.60 $0.00 $0.60
2 $12.20 $0.56 $0.00 $0.56
3 $11.70 $0.83 $0.30 $0.53
4 $11.55 $0.95 $0.45 $0.50
5 $11.90 $0.67 $0.10 $0.57
Start with an soy put option @ $12.00 per bushel29
Options FeaturesAdvantages
Options can establish price floors or ceilingsNot locked in to a particular buyerFlexibleNo margin requirements
DisadvantagesSpecific size of contractCommissions and option premiums
Store Cash Bushelsand Buy Put Option
Put Option
• A put option is the right, but not the obligation to sell futures. The buyer of the option pays a premium for “price insurance” to the downside.
• Market Lower: Put option gains value to offset cash loss.
• Market Higher: Put premium is only cost.
Store cash bushels and buy put option strategy
• A combination of a cash position (owning the cash bushels) and a risk management position (buying the put).
• The put option gains value as market goes lower (as cash bushels lose value).
• If market moves higher, the cash position gains value and the put option is limited to the loss of the option premium.
Estimated Floor Price Calculation
July Corn Put Strike Price less Premium Paid less estimated basis = Est. Floor Price*
$4.60
- 26¢ premium
- 30¢ est. basis
= $4.04
*Option examples do not include commissions and interest
Store Cash & Buy Put OptionFutures Put equals less equalsMarket Option less Net Basis Cash
Outcome Worth Premium Futures Estimate Estimate
+ 1.00
+ 0.75
+ 0.50
+ 0.25
- 0.25
- 0.50
- 0.75
- 1.00
Today'sfutures
$5.60
$5.35
$5.10
$4.85
$4.60
$4.10
$3.85
$3.60
$4.35
0.00
0.00
0.00
0.00
+0.25
+0.50
+0.75
0.00
+1.00
-0.26
$4.60
-0.26
-0.26
-0.26
-0.26
-0.26
-0.26
-0.26
-0.26
$5.34
$5.09
$4.84
$4.59
$4.34
$4.34
$4.34
$4.34
$4.34
-0.30
-0.30
-0.30
-0.30
-0.30
-0.30
-0.30
-0.30
-0.30
$5.04
$4.79
$4.54
$4.29
$4.04
$4.04
$4.04
$4.04
$4.04
Initial Futures
24
Key points: Store cash bushels & buy put option strategy
• The put option gains as market goes lower (as cash bushels lose value).
• Market higher: cash position gains value and the put option loses only the premium paid.
• Strike Price – Premium – Est. Basis = Est. Floor Price
• Basis is key to the net result of the strategy.
Sell Cash Bushels and Buy Call Option
Call Option
• A call option is the right, but not the obligation to buy futures. The buyer of the option pays a premium for “price insurance” to the upside.
• Market Lower: Call premium is the only cost• Market Higher: Call option gains value.
Sell cash bushels and buy call option strategy
• This is a re-ownership strategy.
• This is price risk management since the cash bushels are sold and the limited risk is the call option premium.
• Call option “replaces” cash ownership Strategy is not considered hedging by IRS.
• The call option tends to gain value as the market moves higher.
• Similar to minimum price strategy of buying put
options and can be reasonable if conditions are right (avoid storage costs, good basis at harvest, lack of carrying charge).
Sell cash bushels and buy call option strategy
Estimated Floor Price Calculation
Cash Sale Price less Premium Paid (to buy July Soy $12.80 call)
= Est. Floor Price*
$12.20
- 55¢ premium
= $11.65
*Option examples do not include commissions and interest
Sell Cash & Buy Call OptionFutures Cash Call equalsMarket Sale Option less Cash
Outcome Price Worth Premium Estimate
+ 2.00
+ 1.50
+ 1.00
+ 0.50
- 0.50
- 1.00
- 1.50
- 2.00
Today'sfutures
$14.30
$13.80
$13.30
$12.80
$11.80
$11.30
$10.80
$12.30
$14.80
$12.20
$12.20
$12.20
$12.20
$12.20
$12.20
$12.20
$12.20
$12.20 +2.00
+1.00
0.00
0.00
+0.50
0.00
0.00
0.00
+1.50
-0.55
-0.55
-0.55
-0.55
-0.55
-0.55
-0.55
-0.55
-0.55
$13.15
$12.65
$12.15
$11.65
$11.65
$11.65
$11.65
$11.65
$13.65
$12.80
Initial Futures
27
Key points: Sell cash bushels & buy call option strategy
• Re-ownership strategy: price risk transferred from cash market to call option.
• Minimum price: cash price is set and the call option has the limited risk of the premium.
• Cash Sale Price – Premium = Floor Price• Consider when: want to avoid storage costs,
basis is acceptable, lack of carrying charge.
Marketing New Crop
• The 5-year seasonal crop price patterns favor new crop futures to peak during the spring and summer months.
Seasonal Patterns
31
• Historically, corn prices don’t exceed estimated costs of crop production for long periods of time. Consider sales – even before harvest when profit margins are available.
Crop Margins - Corn
Price = $4.20/bu
Cost = $4.46/bu
• Soybean prices don’t exceed estimated costs of production for long periods, but note the trend in recent years. That opportunity to make sales before harvest is especially attractive in 2012.
Crop Margins - Soybeans
Price = $10.75/bu
Cost = $11.13/bu
2014 Costs Annual estimates from ISU Extension
Publication A1-20, January 2014
Cost of Production
Corn following Soybeans = $4.29/buCorn following Corn = $4.97/buSoybeans = $11.13/bu
Harvest Delivery
Reduced Storage/Drying Costs Bushels that can be sold and moved to
market at harvest will result in less bushels to store and perhaps reduce corn drying costs.
10,000 bu. of soybeans valued @ $13/bu8 cent in/out charge + 3 months of 4% interest
8¢ + 12¢ = 20¢ per bushel
20¢ X 10,000 bu = $2,000 savings!
Key points:
• Keep good records to determine your cost of crop production; estimate your profit margin and compare to harvest delivery prices.
• Seasonal crop price patterns favor new crop futures to peak during the spring and summer months.
• Bushels that can be sold and moved to market at harvest will result in fewer bushels to store, perhaps reduced corn drying costs and an opportunity to generate cash flow needs.
Conquer Marketing Concerns38
Revenue Protection = Over 90% of Iowa’s Insured Acres
Crop Insurance Coverage
Marketing Strategy• Pre-Harvest Sell for
Delivery up to 136 Bu/A
• Price Guarantee is Higher of the Projected Price vs. Harvest Price
• Slight Basis Risk
• Must Plant the Crop
(Prevented Planting = 60%)
170 Bu/AActual
Production History(APH)
RP @ 80% Level of Coverage
136 Bu/AGuarantee X
$4.62/bu Projected Price
Deductible20% = 34 Bu/A
= $628/A Revenue Guarantee
Selling Insurance Bushels
• Corn Actual Production History (APH) of 170 bu/A• Revenue Protection @ 80%(170 X .80 = 136 bu/A)• Revenue Guarantee:136 bu/A X $4.62/bu = $628/A• Drought: Actual yield is 100 bu/A, price = $7.50/bu• New Revenue Guarantee: 136 bu/A X $7.50/bu =
$1,020/A• Revenue to Count: Harvests 100 bu/A X $7.50/bu =
$750/A• Indemnity Payment: $1,020 - $750 = $270/A• Shortfall of Delivery Bushels: Settle by Nov. 1st
Corn Indemnity Payments
Corn Insurance Prices
Soybean Insurance Prices
Key points:• Revenue Protection (RP) can easily be used in
combination with a pre-harvest sales strategy that commits guaranteed insurance bushels to delivery.
• Use of forward contracts and/or HTA contracts are common tools for selling crop insurance bushels committed to delivery.
• Bushels that you prefer not to commit to delivery, consider protecting prices using futures hedges and/or buying put options.
• .
Marketing New Crop
• The 5-year seasonal crop price patterns favor new crop futures to peak during the spring and summer months.
Seasonal Patterns
31
• The traditional 5-year seasonal crop price pattern favored new crop futures peaking during spring & summer months.
• Recently, it appears the seasonals have flattened. Market with revenue margins as the objective!
Seasonal Patterns
31
Crop Marketing Matrix
Futu
res
Pric
eFu
ture
s Pr
ice
Basis Basis
1. Store & wait2. Delayed price contract3. Minimum price contract
(open basis)
1. Basis contract2. Sell Cash Bushels and
Buy Futures or Call Option3. Minimum price contract (fixed basis)
1. Hedge2. Non-roll hedge to arrive3. Buy put option
1. Cash sale now2. Forward Contract
43
Corn and soybean marketing simulation
Practice with forward contracts, futures & options
Periodic e-mails to support learning
The simulation will end in October, 2014.
Participants are invited to play the Commodity Challenge simulation
to experiment with marketing tools and planning.
The plan is to market the insurance guaranteed bushels before harvest:
Corn APH of 180 bpa X 600 acres = 108,000 bushels; 75% is 81,000 bu. available to market.
Soybean APH of 50 bpa X 600 acres = 30,000 bushels; 75% is 22,500 bu. available to market.
2014 New Crop Iowa Commodity Challenge
Click Click JoinJoin
Go to www.commoditychallenge.comGo to www.commoditychallenge.com
Click Click JoinJoin
Fill out Fill out the formthe form
Including Including password password you createyou create
Click Find a Click Find a Game, select the Game, select the 2014 New Crop Iowa Commodity Challenge and click joinand click join
Enter the Enter the game game passwordpassword
www.extension.iastate.edu/agdm/info/icc.html
Web address on page #47
Written Plan to manage emotions
Marketing Tools Workbook
Updated Weekly Tracking Table and Charts on: www.extension.iastate. edu/agdm/info/icc.html
Updated Weekly Tracking Table and Charts on: www.extension.iastate. edu/agdm/info/icc.html
Updated Weekly Tracking Table and Charts on: www.extension.iastate. edu/agdm/info/icc.html
Updated Weekly Tracking Table and Charts on: www.extension.iastate. edu/agdm/info/icc.html
Updated Weekly Tracking Table and Charts on: www.extension.iastate. edu/agdm/info/icc.html
Updated Weekly Tracking Table and Charts on: www.extension.iastate. edu/agdm/info/icc.html
Updated Weekly Tracking Table and Charts on: www.extension.iastate. edu/agdm/info/icc.html
Online Curriculumwww.extension.iastate.edu/agdm/info/icc.html
Marketing Tools Workbook
For Questions about this program, please contact:
Chad Hart Assoc. Professor
of Economics, Iowa State University
Steve JohnsonISU Extension
Farm Management Specialist
Ed Kordick Commodity Services
Manager,Iowa Farm [email protected]