Posted by: usset001 | September 29, 2009

Post Harvest Marketing Alternatives for the 2009 Crop (continued)

peterpaperfarmer

Peter Paperfarmer

Yesterday I started to address the marketing dilemma faced by too many producers on the eve of the 2009 harvest: a large crop is on its way and they are “undercontracted” for new crop delivery. What marketing alternatives are available to the undercontracted farmer?

For producers with on-farm storage, I discussed the “put it storage and pray for a rally” strategy. While it is not a cinch to make money, history (and May Sellers performance) suggests pretty good odds. But this is a big crop – what should we do with bushels where on-farm storage is no longer an alternative?

Let’s meet Peter Paperfarmer, my celebrity producer who illustrates the ever-popular strategy of re-ownership with call options. Every harvest, Peter sells his corn and soybeans off the combine, then re-owns the crop with an at-the-money July call option. He holds the options until it expires in mid-June. Peter’s performance over the last two decades (1989-2008)  is decidedly mixed, depending on whether we talk corn or soybeans, and whether we talk large or small carrying charge markets. (FYI, you can find Peter and all of my celebrity producers here.)

In corn, Peter’s re-ownership strategy made money in 4 of 20 years, or 20% of the years. It is interesting to note that, on average, Peter made money on options over the past two decades, thanks to one incredible year (2007) where a $2.75 per bushel profit more than made up for a string of 15-20 cent losses. At-the-money July’10 corn calls currently cost a little less than 40 cents per bushel.

Peter’s record in soybeans is very different. Peter profited from re-ownership in half of the years, including 7 of the past 8 years. Since 2000, the premium paid for an at-the-money call option varied widely, from 30 cents to $1.21 per bushel last year.

The conclusion looks simple enough; avoid re-ownership strategies in corn and give them a serious look in soybeans. However, we can take our understanding of Peter’s success deeper by differentiating between “large carry” and “small carry” years. Large carrying charges – defined here as the carry from December to July futures greater than 140% of interest costs – are common in the corn market (15 of the last 20 years) and uncommon in soybeans (no years).

In 15 years when carrying charges were large in corn, Peter’s re-ownership strategy made money twice. Peter’s record of success was not good in corn, and concentrating on large carry years just made it worse. And this year? Carrying charges in the corn market are very large, while they are small (as usual) in the soybean market.

My understanding is deeper but the conclusion remains the same; avoid re-ownership strategies in large carry markets (often in corn) and give them a look in small carry markets (the norm in soybeans).  As you consider re-ownership in soybeans, keep in mind that an at-the-money July’10 call will cost more than 80 cents per bushel, and that past performance is no guarantee of future results.


Responses

  1. i think that if one does decide to re-own with call options one thing that needs to be done is a follow up exit plan for the options…..that isn’t a wait until they expire plan either…….if one was a “trader” and then bought something for speculating they would have a target…..same thing should be done when buying options…..if you spend 20 cents what are you hoping to get out of it????


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