Posted by: usset001 | September 13, 2010

Do corn and soybean storage strategies and call options pay after harvest?

Warning! This is a long post.

Late last week a colleague forwarded an article to me from the September 2010 issue of Farm Futures titled “Corn-Soybean Two-Step,” written by Bryce Knorr. It is a brief summary of results for corn and soybeans storage strategies from 1985-2009. (FYI, the September issue is not yet posted on-line, but the study behind the article is on the website) It caught my eye because I have a similar ongoing study with my celebrity producers, though my data starts four years later (1989).

The Farm Futures study looks at 9 different strategies, year by year since 1985, including paper farming with futures contracts (sell grain at harvest and re-own with July futures) and four related strategies of paper farming with options (sell grain at harvest and re-own with in, at, or out-of-the money options. The study also explores selling the carry (store grain at harvest and sell July futures), storing grain and buying July puts, storing unpriced grain on the farm, and storing unpriced grain in commercial storage. The point of this recap shows that, on average, all of these storage strategies had a positive return since 1985, but few did well in 2009.

I have three celebrity producers who replicate these strategies. Peter Paperfarmer sells grain at harvest and re-owns with at-the-money options. Sally Sellthecarry stores grain on-farm and sells the carry with July futures. May Sellers stores unpriced grain on-farm to sell later in the spring.

They got lots of data and results and I got lots of data and results, all over a similar time-frame – let’s compare and contrast.

Paper farming with call options: The Farm Futures study shows that, on average since 1985, all of the paper farming strategies showed a positive return over the harvest price, about 10 cents per bushel in corn and 35-40 cents in soybeans. Peter Paperfarmer shows a 4 cent profit in corn (1990-2009 – the website currently shows 1990-2007 results. Website updates through 2009 are about 6 weeks away) and about 36 cents per bushel in soybeans (1990-2009, again updates forthcoming soon).

While it is nice to see that we generally agree on average, I think averages disguise the bigger picture. Whenever I discuss my celebrity results, I make it a point to show that, while Peter made money on average in corn, his chances of making money in any particular year are not good. In my data, Peter’s re-ownership strategy in corn resulted in a price worse than the harvest price in 16 of 20 years! Peter’s impressive average is the result of the 2007/2008 crop year, when the purchase of July calls earned a profit of nearly $3 per bushel. 1995/1996 was the only other year with more than $1 per bushel profit.

To say that paper farming with July corn calls generates an average of 10 cents per bushel profit puts a very different spin on my conclusion; paper farming with call options will result in a loss in 8 of 10 years.

Peter’s results in soybeans, like the Farm Futures study, are more impressive. An average profit of 36 cents per bushel demands attention but, even in soybeans, your chance of beating the harvest price is 50-50. Again, several spectacular years have skewed the average. Farm Futures and I agree that since 1990, there have been 4 years when re-ownership with ATM calls generated $1 or more in profit per bushel.

I’ve used Peter Paperfarmer as my guinea pig for exploring the effectiveness of re-ownership strategies before and after harvest, in wheat, corn and soybeans. Over the past two decades, the only great fortune he has experienced has been after harvest with soybeans. To which I must add, past performance is no guarantee of future results.

As you might expect, Farm Futures results for options are not exactly the same each year due to different assumptions. Peter re-owns an at-the-money July call on November 1 – I don’t know the re-ownership date used in the Farm Futures study. Peter holds to expiration in mid-June and pays one cent in brokerage (two cents when he takes a profit) but I don’t know Farm Futures assumptions.

Store and sell July futures (selling the carry): In corn, the Farm Futures study showed an average profit just a few cents better than the paper farming strategies. In soybeans, the magazine showed a very small average profit (the smallest of all strategies considered). My celebrity producer, Sally Sellthecarry, is an imperfect comparison because Sally only sells the carry when carrying charges from new crop futures (December corn and November soybeans) are large and positive to the July contract. It makes little sense to sell July futures if the carrying charge is small – it makes absolutely no sense to sell the carry when the carry at harvest is inverted.

I find it hard to compare Sally to the Farm Futures results because it is not an apples-to-apples comparison. I do find it interesting that the Farm Futures strategy of storing grain and buying July puts performed better than storing grain and selling futures. I was momentarily puzzled, but I found the answer in their next strategy; store unpriced grain on-farm

Storing unpriced grain on-farm: Farm Futures shows this as the most profitable strategy (again, on average) since 1985. My celebrity producer, May Sellers, does the exact same thing, holding unpriced corn and soybeans in the bin from mid-October to the last week of May (once again, I don’t know Farm Futures assumptions concerning the start date and end date of storage). The Farm Futures study nets out interest costs, while my analysis considers interest costs and an in-and-out handling and shrink cost of 8 cents per bushel in corn and 11 cents in soybeans.

Our ongoing studies agree that the best strategy over time has been store and hold to spring (like May Sellers) or until ?? in the Farm Futures study. If a producer told me that their post-harvest strategy was to store grain at harvest and sell it in the April-June period, I would not argue with the long term value of that approach. I would, however, make sure to warn them that this approach can be risky from one year to the next (our latest crop year being the most recent example – prices were generally lower in spring than at harvest). My analysis shows that May Seller’s approach will lose money in about one of every three years, but some of the winning years have been spectacular (2007/2008 comes to mind again).

Now about that strategy of storing grain and buying July puts. I was puzzled because it was clearly better (on average) than selling the carry. I’m making a comparison to the wrong strategy. The relevant comparison is storing grain and buying July puts vs. simply storing unpriced grain. It is the same strategy, except for the purchase of put options to establish “downside” protection. According to the Farm Futures study, over the long run buying put options after harvest cost 4 cents per bushel in corn and 25 cents per bushel in soybeans.

The spectacular run of prices in 2007/2008 may skew the results after harvest, but I still believe that in the long run, options will cost money.

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