Crop Marketing Hancock County Grain Marketing Garner Iowa

Crop Marketing Hancock County Grain Marketing Garner, Iowa Feb. 6, 2017 Chad Hart Associate Professor/Crop Markets Specialist chart@iastate. edu 515 -294 -9911 Extension and Outreach/Department of Economics

Marketing A series of events and services to create, modify, and transport a product from initial creation to consumption Possible steps: ØPlanning ØProduction ØInspection ØTransport ØStorage ØProcessing ØSale Market players: ØProducers ØElevators ØProcessors ØTransport companies ØBanks/Insurance companies ØTraders ØFeeders Extension and Outreach/Department of Economics

Cash Markets A market where physical commodities are traded ØLocal elevators ØEthanol plants & soybean crushers ØRiver terminals ØFeeders/feed mills Extension and Outreach/Department of Economics

Futures Markets A market where contracts for physical commodities are traded, the contracts set the terms of quantity, quality, and delivery ØChicago: Corn, soybeans, cattle, hogs ØAlong with wheat (soft red), oats, rice ØKansas City: Wheat (hard red winter) ØMinneapolis: Wheat (hard red spring) ØTokyo: Corn, soybeans, coffee, sugar ØHas a market for Non-GMO soybeans ØOther markets in Argentina, Brazil, China, and Europe Extension and Outreach/Department of Economics

The Cash and Futures Markets Are Related Basis = Cash price – Futures price Rearranging terms: Cash price = Futures price + Basis So national (and international) events can affect local prices Extension and Outreach/Department of Economics

Cash vs. Futures Prices Iowa Corn in 2016 The gap between the lines is the basis. Extension and Outreach/Department of Economics

2016 Basis for Iowa Corn Extension and Outreach/Department of Economics

Agricultural Markets ØHas some unique features due to the nature of agricultural businesses ØSupply comes online a few times during the year ØSo at harvest, supply spikes, then diminishes until the next harvest ØProduction decisions are based price forecasts ØPlanting decisions can be made a full year (or more) before the crop price is realized ØUsers provide year-round demand ØLivestock feeding, biofuel production, food demand Extension and Outreach/Department of Economics

Cash Contracts Ø When we talk about a cash contract, it is an agreement between a seller and a buyer covering a quantity and quality of a product to be delivered at a specified location and time for a specific price Ø If the time is now, we call it a “cash” contract Ø If the time is sometime in the future, then it’s a “forward cash” contract Extension and Outreach/Department of Economics

The Highest Cash Price Is … … Not always the highest return Need to think about transportation and storage costs Compare the cash prices we’ve seen today: Ø If storage is costing me 3 cents/bushel/month, do the May bids look better than the current cash price? Ø If transportation is costing me 0. 5 cents/bushel/mile, which is the better price? Forest City (13 miles) Kiester, MN (35 miles) Albert Lea, MN (49 miles) Clear Lake (12 miles) Extension and Outreach/Department of Economics

Cash vs. Futures Hedge Ø Cash Sales Ø Locks in full price and delivery terms Ø No margin requirements Ø Futures Hedge Ø Locks in futures price, but leaves basis open Ø Could see price improvement/loss Ø Can be easily offset if problems arise Extension and Outreach/Department of Economics

Average Iowa Corn Basis, 2010 -14 Source: http: //www. extension. iastate. edu/agdm/crops/pdf/a 2 -41. pdf Extension and Outreach/Department of Economics

Seasonal Patterns Ø A price pattern that repeats itself with some degree of accuracy year after year. ØSupply and demand ØOften sound reasons ØWidely known ØLinked to storage cost or basis patterns in grains ØLinked to conception and gestation in livestock Extension and Outreach/Department of Economics

Seasonal Pricing Patterns Source: USDA, NASS, Monthly Price Data 1980 -2013 Extension and Outreach/Department of Economics

Cost of Ownership Carry shows the additional revenue that can be obtained from holding on to the crop But there are costs to holding on: storage interest/opportunity costs These are known as the cost of ownership If the carry more than covers the cost of ownership, then it’s referred to as “full carry” Extension and Outreach/Department of Economics

Corn Cost of Ownership Assumption: Corn is Valued at $3. 50/bu Financed @ 5% APR Extension and Outreach/Department of Economics

Carry (or Spread) The price difference between futures contracts Compare the carry offered by the market to the costs of storing grain from one delivery month to the next. Extension and Outreach/Department of Economics

Corn Futures Carry Date: 4/10/15 July $4. 26 May $4. 20 Mar $4. 13 Dec $4. 02 Extension and Outreach/Department of Economics

Corn Futures Carry Date: 11/17/11 Date: 4/3/12 May $6. 58 July $6. 34 May $6. 30 July $6. 53 Extension and Outreach/Department of Economics

Inverse Carry When further out futures are priced at a discount to nearby futures Usually occurs when demand is strong and the need for the crop is immediate Can also occur during short crop situations or when there is a large crop coming in after a tight stock situation Basis is usually stronger in an inverse market Extension and Outreach/Department of Economics

Corn Futures Carry Date: 4/12/13 May $6. 58 July $6. 41 Sept $5. 77 Extension and Outreach/Department of Economics

Short Hedgers Ø Producers with a commodity to sell at some point in the future ØAre hurt by a price decline Ø Sell the futures contract initially Ø Buy the futures contract (offset) when they sell the physical commodity Extension and Outreach/Department of Economics

Short Hedge Expected Price Ø Expected price = Futures prices when I place the hedge + Expected basis at delivery – Broker commission Extension and Outreach/Department of Economics

Short Hedge Example Ø As of Jan. 20, Nov. 2017 soybean futures Historical basis for Nov. Rough commission on trade Expected price ($ per bushel) $10. 29 $-0. 30 $-0. 01 $ 9. 98 Ø Come November, the producer is ready to sell soybeans Ø Prices could be higher or lower Ø Basis could be narrower or wider than the historical average Extension and Outreach/Department of Economics

Prices Went Up, Hist. Basis Ø In November, buy back futures at $11. 50 per bushel Nov. 2017 soybean futures Actual basis for Nov. Local cash price Net value from futures ($ per bushel) $11. 50 $-0. 30 $11. 20 $-1. 22 ($10. 29 - $11. 50 - $0. 01) Net price Extension and Outreach/Department of Economics $ 9. 98

Prices Went Down, Hist. Basis Ø In November, buy back futures at $7. 00 per bushel Nov. 2017 soybean futures Actual basis for Nov. Local cash price Net value from futures ($ per bushel) $ 7. 00 $-0. 30 $ 6. 70 $ 3. 28 ($10. 29 - $7. 00 - $0. 01) Net price Extension and Outreach/Department of Economics $ 9. 98

Short Hedge Graph Hedging Nov. 2017 Soybeans @ $10. 29 Extension and Outreach/Department of Economics

Prices Went Down, Basis Change Ø In November, buy back futures at $7. 00 per bushel Nov. 2017 soybean futures Actual basis for Nov. Local cash price Net value from futures ($ per bushel) $ 7. 00 $-0. 10 $ 6. 90 $ 3. 28 ($10. 29 - $7. 00 - $0. 01) Net price Ø Basis narrowed, net price improved Extension and Outreach/Department of Economics $10. 18

Options Ø What are options? Ø An option is the right, but not the obligation, to buy or sell an item at a predetermined price within a specific time period. Ø Options on futures are the right to buy or sell a specific futures contract. Ø Option buyers pay a price (premium) for the rights contained in the option. Extension and Outreach/Department of Economics

Option Types Ø Two types of options: Puts and Calls Ø A put option contains the right to sell a futures contract. Ø A call option contains the right to buy a futures contract. Ø Puts and calls are not opposite positions in the same market. They do not offset each other. They are different markets. Extension and Outreach/Department of Economics

Options as Price Insurance Ø The person wanting price protection (the buyer) pays the option premium. Ø If damage occurs (price moves in the wrong direction), the buyer is reimbursed for damages. Ø The seller keeps the premium, but must pay for damages. Extension and Outreach/Department of Economics

Strike Prices Ø The predetermined prices for the trade of the futures in the options Ø They set the level of price insurance Ø Range of strike prices determined by the futures exchange Extension and Outreach/Department of Economics

Setting a Floor Price Ø Short hedger Ø Buy put option Ø Floor Price = Strike Price + Basis – Premium – Commission Ø At maturity Ø If futures < strike, then Net Price = Floor Price Ø If futures > strike, then Net Price = Cash – Premium – Commission Extension and Outreach/Department of Economics

Put Option Graph Dec. 2017 Corn Futures @ $3. 9325 Strike Price @ $4. 00 Put Option Return = Max(0, Strike Price – Futures Price) – Premium – Commission Premium = $0. 3425 Commission = $0. 01 Extension and Outreach/Department of Economics

Put Option Graph Dec. 2017 Corn Futures @ $3. 9325 Strike Price @ $4. 00 Premium = $0. 3425 Net = Cash Price + Put Option Return Extension and Outreach/Department of Economics

Call Option Graph Dec. 2017 Corn Futures @ $3. 9325 Strike Price @ $4. 00 Call Option Return = Max(0, Futures Price – Strike Price) – Premium – Commission Premium = $0. 2875 Commission = $0. 01 Extension and Outreach/Department of Economics

Thank you for your time! Any questions? My web site: http: //www 2. econ. iastate. edu/faculty/hart/ Iowa Farm Outlook: http: //www 2. econ. iastate. edu/ifo/ Ag Decision Maker: http: //www. extension. iastate. edu/agdm/ Extension and Outreach/Department of Economics