Crop Marketing Hancock County Grain Marketing Garner, Iowa Feb. 6, 2017 Chad Hart Associate Professor/Crop Markets Specialist chart@iastate.edu 515-294-9911 1 1

Marketing A series of events and services to create, modify, and transport a product from initial creation to consumption Possible steps: Planning Production Inspection Transport Storage Processing Sale Market players: Producers Elevators Processors Transport companies Banks/Insurance companies Traders Feeders 2 2

Cash Markets A market where physical commodities are traded Local elevators Ethanol plants & soybean crushers River terminals Feeders/feed mills 3 3

Futures Markets A market where contracts for physical commodities are traded, the contracts set the terms of quantity, quality, and delivery Chicago: Corn, soybeans, cattle, hogs Along with wheat (soft red), oats, rice Kansas City: Wheat (hard red winter) Minneapolis: Wheat (hard red spring) Tokyo: Corn, soybeans, coffee, sugar Has a market for Non-GMO soybeans Other markets in Argentina, Brazil, China, and Europe 4 4

The Cash and Futures Markets Are Related Basis = Cash price – Futures price Rearranging terms: Cash price = Futures price + Basis So national (and international) events can affect local prices

Cash vs. Futures Prices Iowa Corn in 2016 The gap between the lines is the basis.

2016 Basis for Iowa Corn

Agricultural Markets Has some unique features due to the nature of agricultural businesses Supply comes online a few times during the year So at harvest, supply spikes, then diminishes until the next harvest Production decisions are based price forecasts Planting decisions can be made a full year (or more) before the crop price is realized Users provide year-round demand Livestock feeding, biofuel production, food demand 8 8

Cash Contracts When we talk about a cash contract, it is an agreement between a seller and a buyer covering a quantity and quality of a product to be delivered at a specified location and time for a specific price If the time is now, we call it a “cash” contract If the time is sometime in the future, then it’s a “forward cash” contract

The Highest Cash Price Is … … Not always the highest return Need to think about transportation and storage costs Compare the cash prices we’ve seen today: If storage is costing me 3 cents/bushel/month, do the May bids look better than the current cash price? If transportation is costing me 0.5 cents/bushel/mile, which is the better price? Forest City (13 miles) Kiester, MN (35 miles) Albert Lea, MN (49 miles) Clear Lake (12 miles)

Cash vs. Futures Hedge Cash Sales Futures Hedge Locks in full price and delivery terms No margin requirements Futures Hedge Locks in futures price, but leaves basis open Could see price improvement/loss Can be easily offset if problems arise

Average Iowa Corn Basis, 2010-14 Source: http://www.extension.iastate.edu/agdm/crops/pdf/a2-41.pdf

Seasonal Patterns A price pattern that repeats itself with some degree of accuracy year after year. Supply and demand Often sound reasons Widely known Linked to storage cost or basis patterns in grains Linked to conception and gestation in livestock

Seasonal Pricing Patterns Source: USDA, NASS, Monthly Price Data 1980-2013

Cost of Ownership Carry shows the additional revenue that can be obtained from holding on to the crop But there are costs to holding on: storage interest/opportunity costs These are known as the cost of ownership If the carry more than covers the cost of ownership, then it’s referred to as “full carry”

Corn Cost of Ownership Assumption: Corn is Valued at $3.50/bu Financed @ 5% APR

Carry (or Spread) The price difference between futures contracts Compare the carry offered by the market to the costs of storing grain from one delivery month to the next.

Corn Futures Carry July $4.26 May $4.20 Mar $4.13 Dec $4.02 Date: 4/10/15

Corn Futures Carry May $6.58 July $6.34 May $6.30 July $6.53 Date: 11/17/11 Date: 4/3/12 May $6.58 July $6.34 May $6.30 July $6.53

Inverse Carry When further out futures are priced at a discount to nearby futures Usually occurs when demand is strong and the need for the crop is immediate Can also occur during short crop situations or when there is a large crop coming in after a tight stock situation Basis is usually stronger in an inverse market

Corn Futures Carry Date: 4/12/13 May $6.58 July $6.41 Sept $5.77

Short Hedgers Producers with a commodity to sell at some point in the future Are hurt by a price decline Sell the futures contract initially Buy the futures contract (offset) when they sell the physical commodity

Short Hedge Expected Price Futures prices when I place the hedge + Expected basis at delivery – Broker commission

Short Hedge Example As of Jan. 20, ($ per bushel) Nov. 2017 soybean futures $10.29 Historical basis for Nov. $-0.30 Rough commission on trade $-0.01 Expected price $ 9.98 Come November, the producer is ready to sell soybeans Prices could be higher or lower Basis could be narrower or wider than the historical average

Prices Went Up, Hist. Basis In November, buy back futures at $11.50 per bushel ($ per bushel) Nov. 2017 soybean futures $11.50 Actual basis for Nov. $-0.30 Local cash price $11.20 Net value from futures $-1.22 ($10.29 - $11.50 - $0.01) Net price $ 9.98

Prices Went Down, Hist. Basis In November, buy back futures at $7.00 per bushel ($ per bushel) Nov. 2017 soybean futures $ 7.00 Actual basis for Nov. $-0.30 Local cash price $ 6.70 Net value from futures $ 3.28 ($10.29 - $7.00 - $0.01) Net price $ 9.98

Short Hedge Graph Hedging Nov. 2017 Soybeans @ $10.29

Prices Went Down, Basis Change In November, buy back futures at $7.00 per bushel ($ per bushel) Nov. 2017 soybean futures $ 7.00 Actual basis for Nov. $-0.10 Local cash price $ 6.90 Net value from futures $ 3.28 ($10.29 - $7.00 - $0.01) Net price $10.18 Basis narrowed, net price improved

Options What are options? An option is the right, but not the obligation, to buy or sell an item at a predetermined price within a specific time period. Options on futures are the right to buy or sell a specific futures contract. Option buyers pay a price (premium) for the rights contained in the option.

Option Types Two types of options: Puts and Calls A put option contains the right to sell a futures contract. A call option contains the right to buy a futures contract. Puts and calls are not opposite positions in the same market. They do not offset each other. They are different markets.

Options as Price Insurance The person wanting price protection (the buyer) pays the option premium. If damage occurs (price moves in the wrong direction), the buyer is reimbursed for damages. The seller keeps the premium, but must pay for damages.

Strike Prices The predetermined prices for the trade of the futures in the options They set the level of price insurance Range of strike prices determined by the futures exchange

Setting a Floor Price Short hedger Buy put option Floor Price = Strike Price + Basis – Premium – Commission At maturity If futures < strike, then Net Price = Floor Price If futures > strike, then Net Price = Cash – Premium – Commission

Put Option Graph Dec. 2017 Corn Futures @ $3.9325 Strike Price @ $4.00 Put Option Return = Max(0, Strike Price – Futures Price) – Premium – Commission Premium = $0.3425 Commission = $0.01

Put Option Graph Dec. 2017 Corn Futures @ $3.9325 Strike Price @ $4.00 Premium = $0.3425 Net = Cash Price + Put Option Return

Call Option Graph Dec. 2017 Corn Futures @ $3.9325 Strike Price @ $4.00 Call Option Return = Max(0, Futures Price – Strike Price) – Premium – Commission Premium = $0.2875 Commission = $0.01

Thank you for your time. Any questions. My web site: http://www2. econ Thank you for your time! Any questions? My web site: http://www2.econ.iastate.edu/faculty/hart/ Iowa Farm Outlook: http://www2.econ.iastate.edu/ifo/ Ag Decision Maker: http://www.extension.iastate.edu/agdm/