This spring has been different, to say the least, but then again every spring is different, at least when it comes to agriculture. There has been a great deal of uncertainty in the markets this winter and spring. As far as the weather is concerned, we only have four choices, and those are: too hot, too cold, too wet or too dry. In recent years, we haven’t had to worry too much about it being too wet, but I’m sure that weather cycle will change one day.
As far as the markets are concerned, we are dealing with the uncertainty in the prices we pay for inputs as well as the prices we receive for our commodities. I recently had a producer (who doesn’t follow the markets) ask me: “Are the markets up or down today?” I simply said “yes.” After all, he didn’t ask what the trend was, and we all know that most days we usually trade both sides of the market during the session. That is why it is important for you to at least look at where your specific futures market closed for the day.
Since the middle of February, the wheat futures have been so volatile we have seen days of a 30-cent range up to days where the range was over $1.30. This volatility has, without a doubt, changed the way some buyers do business. There was a time when you would give a producer a bid for their wheat and they would ask how long this bid was good for – and the answer would be anything from a few hours to a day. Then the markets changed, and the answer for that question would be “as long as we are on the phone.” Now there are buyers who won’t set the price until they have locked in the futures for their hedge.
Yes, I did say futures and hedge in the same sentence. After all, that is how they manage their price risk – when they buy wheat, they sell futures in order to manage their price risk in the futures market. Then when they sell the wheat, whether it is whole grain or in flour, they simply buy their futures position back. By doing this, they are able to protect themselves against an adverse price movement in the futures. Simply put, they are trading the basis, and all large grain companies as well as flour mills use these tools.
What these companies do is nothing new. Grain companies and flour mills have been hedging their cash grain positions using the futures markets for many years. So let’s take just a moment and visit about hedging using the futures market. When you are long wheat (own wheat), you would sell futures. This is simply a substitute sell into the cash market. This is a strategy that lets you manage the futures side of your price risk.
Now, I know that nothing is perfect and there will always be two sides to every story. Keeping this in mind, we will be discussing just the positive side of the market and the positive side of the strategies for today. That doesn’t necessarily mean there is a negative side to what we are talking about.
Once you have the futures priced, if the futures market trends lower, you are protected penny for penny into the lower market. This isn’t a way for you to necessarily make more money, but it’s a very good strategy to help you manage your price risk in the market. Now that you are hedged, you are able to simply trade the basis. This is when you watch and monitor the basis for a strengthening trend or a quick jump to the upside. Remember, the basis is a very good indicator of your local supply or demand. When you see the basis in your area strengthen, you know somebody wants to buy grain, and we know from experience it is always good to sell when someone wants to buy. After all, once the buyer has bought in their needs, the basis will once again weaken.
Once you contract your cash grain, you then buy the short futures position back. Sounds simple enough, doesn’t it – well, it is and it isn’t. Using futures to manage your price risk is more than just jumping in. It does take some time and effort on your part. If you don’t study and understand the basics of hedging with futures, you probably won’t have a good experience; however, using your knowledge of hedging and trading the basis, you will make wise decisions and use this strategy as part of your marketing plan in the years ahead. Today, we talked about hedging wheat or grain, but these strategies will also work for those who are in the cattle industry.
Using the futures to hedge your commodities will work for you, but you will need to take the time to study and learn just how they will benefit you in your operation.
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