Futures and Options Work for Price Protection | Agriculture / Energy

Farmers are fortunate that even though input costs have increased dramatically, grain prices have also increased.

What are you doing to protect this value? Hopefully cash grain that was physically in storage will be sold and loaded onto a train or barge and headed to port. What do we do with the crop that is currently growing?

Futures and options are one place to look for price protection. During volatility spikes, margin calls are incredibly difficult to make unless a trade is very liquid.

Options are also prohibitively expensive, with premiums eroding the underlying protected price. Even with these negative forces present, it is a better option than doing nothing.

If you’re not comfortable with the futures market, you might want to explore spot contracts. The biggest fear of producers with a spot contract is to deliver. If I contract a bushel of wheat at $10.00 and the market rises to $12.00 at harvest, I will only receive $10.00/bushel. for this grain delivered. If I cannot grow that bushel of wheat due to drought or some other disaster, I will have to buy a bushel of wheat on the open market at $12.00 to cover my $10.00/bushel. contract and my net loss is $2.00/bu. in the simplest terms.

This leads farmers to be very careful with spot contracts. However, there is another strategy to consider. Most producers carry crop insurance on their wheat acres. This crop insurance guarantees income consisting of a cash price and a yield guarantee. If the harvest price exclusion has not been selected (it is usually not the case), the revenue calculation uses the higher of the initial price and the harvest price. It appears that the harvest price of wheat will be much higher than the price used in the initial revenue calculation at the present time.

If my approved yield (APH) is 40 bu/ac and I have 70% coverage, then my guaranteed yield is 28 bu/ac. This means I can cash in a 28 bushel wheat per acre contract and enter the current price. If the price goes up by harvest and I can’t raise the bushels to cover the contract, my crop insurance will provide me with the revenue to buy out the unfulfilled contract.

It’s not some obscure marketing ploy, but many growers don’t take advantage of it. Adjust your current risk protection to take advantage of this fear and uncertainty in the market. While prices have the fundamental support to remain high right now, this market dynamic could change. Position yourself and your farm to counter high input costs and take advantage of these historically high prices.

Milacek is an Agricultural Economics Specialist for the Western District of the Oklahoma Cooperative Extension Service.

Maria D. Ervin