Posted by: usset001 | August 21, 2010

Grain marketing: Margin calls are good

For hedgers, that is. The past six weeks have been good for the prices of wheat, corn and soybeans (in that order). Anyone who sold futures earlier in the summer or last spring saw the rally as losses in their hedge account.

Are losses in a hedge account bad? I tell producers to see the whole picture behind a trading decision. Let me illustrate with an example.

Let’s assume you made a decision in May to price 50% of your anticipated corn crop. To make this happen, you called your broker and sold 20 contracts (100,000 bushels) of December corn futures at $3.95 per bushel. December corn futures are now trading 40 cents higher and your margin account show a loss of $40,000 (20 contracts * 5,000 bushels * 40 cents per). Bad decision, right?

See the whole picture – this loss is more than offset by the increasing value of your corn developing in the field. Because you priced only half of your crop, the other half of your crop is still increasing in value and your total expected revenues from the crop are still rising.

What if December corn futures were trading at $3.55, or 40 cents lower than your original sale? Your margin account would be fat with $40,000 in new revenues. Is this better? Hardly – that fat margin account covers the cash value loss on only one-half of your crop. These “profits” are more than offset by the fact that 100% of your crop developing in the field is worth 40 cents less. Your margin account looks good but total revenues from soybean sales will be lower.

For the true hedger – one who sees the whole picture behind a pricing decision – margin calls are good. For producers who sell futures contracts to price grain, the need for more margin money is simply a reminder that market prices are trending higher, and that your initial sales were too early and too cheap. Grain producers benefit from higher prices.

Let’s be clear – margin calls are not good if you are using futures to price your next five crops, or if you are speculating on the price of gold. For speculators, their futures position is the whole picture.


Responses

  1. Your site is very good.


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