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Farm Futures selling strategy study: Hedging paid off in 2016

Timing may not be everything, but it sure helped growers hedging 2016 corn and soybeans on seasonal rallies.

When those hedges were made — and when they were lifted — was crucial in determining how marketing plans transferred from paper to practice, according to Farm Futures’ long-term study of selling strategies. Growers who hedged later on the spring and early-summer rally, and harvested early made more profits to add to sales than those who sold first and harvested last.

Still, overall hedges in both crops posted mostly better-than-average returns. That should help hedgers turn a modest profit on their production, thanks also to record yields that reduced the cost of production.

The Farm Futures study looks at the profitability of different strategies, beginning in 1985, when options on ag futures began trading again after a 50-year ban. We don’t actually make any sales; the study is hypothetical, on paper. But we use actual prices for cash markets, futures and options, using a massive database assembled over the decades.

Most years, hedging does earn a better return than the harvest price. But year-by-year results also point out the risks of selling using some strategies. Making sales with futures or hedge-to-arrive contracts generates massive hedging losses in years when prices rally later and yields fall. This can make some strategies look better than others, depending on how much variability your operation can withstand.

Our study found that options strategies earned less than straight sales in 2016, a year prices rallied when they normally do, and collapsed into harvest, their usual pattern, too. Options were unneeded insurance, a cost that reduced the effectiveness of sales as a result. And in some locations, this meant that early sales actually lost money compared to the harvest price.

Three sales windows

The study looks at three sales windows: the second week of April, third week of May and fourth week of June. In addition to sales with futures/HTAs and purchases of put options, the study includes sales covered by call options. The call options are assumed to be purchased at the end of February, April and May — periods when prices tend to be weaker, making the calls cheaper.

The study also looks at average pricing strategies popular with some cash contracts. Two windows are used: Jan. 1 to Sept. 1 and March 1 to Sept. 1.

Straight hedges without options this year netted 40 cents a bushel for corn, compared to 17 cents for at-the-money puts at the 11 locations surveyed. Soybean hedges made 79 cents, with puts netting 46 cents at nine locations.

Futures did best for soybeans over the entire 32 years of the study, earning an average of 32 cents compared to 16 cents for the at-the-money put. That result is in line with options theory, which says the at-the-money option normally reflects about half the move in the underlying futures contract.

But the long-term results for corn are quite different, pointing out the downside to hedging. The sell futures or HTA/buy call strategies made 15 cents, a penny more than the straight sales. And it mattered little what value call was purchased: Covering the sale with a call two strikes out of the money made as much as buying an at-the-money one.

While calls are a cost, they paid off big on paper in some of the volatile years corn is known for. During the historic 2012 drought, hedges lost more than $3 bushel, which the options mitigated.

Big losses from early hedges in corn bull-market years also eroded the effectiveness of average pricing systems, making them less effective overall than selling futures/HTAs and buying calls, a strategy known as a synthetic put.

This year’s results also showed how basis can affect hedging performance. Farmers who planted and harvested corn later than normal, or whose harvest was delayed by rain or huge yields, tended to earn less from hedges. While December futures bottomed in early October, corn basis tended to be stronger, then weakening as more of the crop piled up. Early harvesters tended to add greater hedge profits to a higher cash basis as a result.

Soybean basis didn’t weaken quite as quickly as corn faded, and most areas as usual harvested beans first. Only states that harvested later, like Kansas and Missouri, suffered as a result, with most locations earning $45 to $50 an acre from hedges over the harvest price.

Corn

1985-2016 Summary By Terminal
1985-2016 Summary By Year
2016 Summary By Terminal
Central Illinois
Central Indiana
Cincinnati
Denver
Evansville
Garden City, KS
Kansas City
Minneapolis
North Central Iowa
Omaha
Toledo
 

Soybeans
1985-2016 Summary By Terminal
2016 Summary By Terminal
1985-2016 Summary By Year
Central Illinois
Central Indiana
Cincinnati
Garden City, KS
Kansas City
Minneapolis
North Central Iowa
Omaha
Toledo

TAGS: Corn Soybean
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