With corn and soybean prices near seasonal lows, producers are considering taking their loan deficiency payments (LDPs). But one analyst suggests following this move with a strategy to take advantage of any rise in price.
William Tierney, professor of agricultural economics at Kansas State University, told growers at the Ag Market Network teleconference in November that a good incentive exists for executing a storage hedge for corn, essentially “putting grain in storage and selling a deferred futures contract.”
Tierney pointed to the relationship between the July 2002 corn contract and the December 2001 contract. “Last Friday (Nov. 9), we were looking at a spread of a positive 25 cents. That is what the market is currently offering people not to deliver grain in September, but to hold it until July.”
The spread, relative to the costs of carrying the grain (storage plus interest costs), “is the largest incentive we've ever seen. I went all the way back to 1973 and could only find two other years — 1979 and 1981 — when in the first week in November, you had a spread larger than 25 cents between the July and December contracts.
“In effect, the farmer puts grain in on-farm storage, sells the July futures contract, or sells the March and rolls it over to the May and then July. You need to talk to your broker about which one to do. If you did it relative to July and you have below-average basis levels at harvest, you're going to lock in the 25-cent spread in anticipation of an appreciation in basis.”
Tierney believes “there is a reasonable expectation that we could have as much as a 40- to 60-cent rally in the July futures contract from Dec. 1 until the expiration of the futures contract.”
If you don't have on-farm storage or you don't want to do a storage hedge, Tierney suggest buying a deferred call option or futures contract.
What about soybeans?
“October tends to be the month for the seasonal low for soybean prices,” Tierney said. “I believe we have seen the low in the market, but it's not dramatically lower than where we are today. On Nov. 12, November soybean futures closed at $4.45. We had gotten down to $4.20. But I think we've see the highest LDPs of the year.”
On the other hand, “the carry in the soybean market is certainly not very attractive,” Tierney said. I probably would not consider on-farm storage.”
However, Tierney said, his technical analysis indicates that there is a 96 percent chance that between Dec. 1 and the expiration of July 2002 contract — about 8.5 months — that the range between the high and low price will be 80 cents.
In addition, “there is a 90 percent chance that the range between the high and low will be a dollar. On a cash basis, the national average price of soybeans is the lowest going back to 1973.
“If we're at some 27-year lows in terms of the cash market and we have a 90 percent chance of seeing a dollar range, where do you want to bet where we are today: the low end of the July futures contract, or the high end? I say the odds are good that we are at the low end.
“Based on that outlook, I suggest that soybean producers take the LDP, dispose of the physical ownership of the beans, then buy a July call option.”
Those options could appear to be expensive, notes Tierney. “On Nov. 9, we were looking at July beans trading at $4.58 and you could purchase a $4.60 July call for 28 cents.
“But if you wanted to reduce the cost of post-harvest ownership, you could execute a vertical call spread. After you purchase the $4.60 call, you could sell a $5.60 July call for 8 cents.
“Your net cost is 20 cents plus commission. So you have out-of-pocket costs of 21 to 22 cents. In return, you have up to a dollar upside potential. If the July futures contract goes above $5.60, you don't make any more money.”
Selling a call option does expose you to the possibility of margin calls. Make sure you are willing to accept all the risks before attempting strategies involving futures and options.
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