Opt For Options

In a weak commodity market, strategy provides downside protection until seasonal patterns offer opportunities.

Katie Micik Dehlinger
By  Katie Dehlinger , Farm Business Editor
Erik Oberbroeckling says Oberbroeckling Farms’ on-site storage is run like a co-op, with the bins there to capture carry. The farm added 410,000 bushels of capacity over 10 years, Image by Mark Tade

Oberbroeckling Farms ‌decided to go all in ‌with on-farm storage ‌in the mid-2000s. It expanded capacity from 30,000 bushels to 470,000 bushels during the next decade.

The bin building required a change in marketing mind-set.

“The bins are there to capture carry, not to put unpriced grain in while you hope and pray for a rally. Hoping and praying is not a marketing strategy,” 34-year-old farm manager Erik Oberbroeckling says. “I essentially try to run my on-farm storage just like a co-op would.”

That means he usually has three years of grain sales on the books at one time: old crop, current crop and the next year’s crop. He uses options strategies to hedge and manages the two components of his cash price--basis and futures--separately to make the most of each.

With corn in a range-bound market and soybean prices below many producers’ break-even levels, Oberbroeckling and several market advisers say options strategies offer good protection as farmers wait for seasonal patterns to present the best pricing opportunities.

“We’re back to seasonality again,” Oberbroeckling says. “It’s time to get back to the basics. Do the little things right.”

OPTIONS IN ACTION. Oberbroeckling writes a marketing plan every year. It gives him a road map of dates, price points and factors to consider, even if he doesn’t always follow them verbatim. The past few marketing years have been similar, with the futures board offering the best pricing opportunities a year or more ahead of time.

Before harvest rolls around, he likes to have about 20% of the next year’s crop (that he hasn’t purchased seed for yet) hedged with options. He adds to that position during winter and spring, bringing that level up to 75 to 80% by the Fourth of July,incorporating some hedge-to-arrive contracts (HTAs).Once the crop is in the bin, he’ll focus on selling it into the cash market.

Floor Price. By following that pattern for the 2018 crops, Oberbroeckling says he’s established a futures price floor on 75% of his soybean crop at $10 per bushel. On corn, 70% of his crop has a minimum price of $4 per bushel using a combination of options and HTA contracts. Those prices include brokerage fees as well as gains and losses from trades that have been closed out.

His favorite option strategy is to buy a put, sell a put and sell a call. For example, he’ll buy a $4-per-bushel corn put, sell a $3.50-per-bushel corn put and sell a $4.50 corn call. That gives him 50 cents of upside potential and 50 cents of downside protection.

Oberbroeckling tries to keep the price of this strategy at less than a dime per bushel of corn. “You’re never going to hit the high with that strategy, but I’d hope you’d at least keep yourself in the top 25% or top third by having the flexibility to be open and not being stuck in a price,” he says.

Not all option strategies need to be as elaborate as Oberbroeckling’s, explains DTN analyst Todd Hultman. An out-of-the-money December corn or November soybean put provides good protection for grain in storage.

“Just having an inexpensive put takes, typically, about 85% of the risk off the table, and you’re only talking about a 3-cent price on corn and maybe a nickel for soybeans, so it’s not a big financial commitment,” he says. That takes away most of the downside risk while you wait for a better price.

Tony McDonald farms in west-central Iowa, near Ralston, but also works as a broker/market adviser. He says there are several futures and options strategies farmers can use. If on-farm storage isn’t available, and you don’t want to pay your local elevator a storage fee, you can sell it across the scales at harvest and buy a call option. This strategy allows you to buy back in if prices hit a certain level.

Oberbroeckling says discipline is an essential part of using options strategies. “You have to essentially sell every bushel twice,” he says, once when you execute the option strategy and then again when you sell the bushel into the cash market. “And, for some people, it’s hard enough pulling the trigger to sell it once.”

CASHING OUT. In September, Oberbroeckling still had a portion of the 2017 corn in the bin. Since the farm can store about 125% of its typical production, he plans to carry it forward into 2019 to sell. “The cash market is offering 30 to 40 cents to carry it from now to next March or April, so why not?” he says.

When it comes to pricing cash grain, Oberbroeckling prefers HTA contracts and basis contracts to standard forward contracts. HTAs lock in the futures price but leave the basis open. Basis contracts lock in the basis but leave the futures component open. A standard forward contract locks in both futures and basis.

Multiple Contracts. Most elevators offer a variety of cash contracts, and those can be helpful if you would rather avoid options. McDonald suggests visiting with your local elevator or cooperative to go through your choices.

“I know OTC [over the counter] products have a bad name in some areas of the world, but at the same time, in this market, can it help you?” he says. Before you enter into an OTC contract, make sure you know the parameters and risks, and be absolutely sure you can deliver on your commitments.

For the 2019 crop, Oberbroeckling will start considering HTAs over options in spring, and if the market is paying him to store grain, he’ll roll those HTAs forward to pick up the carry. “As far as basis, know your local patterns. That’s the big thing,” he says.

His farm sits just 2 miles from the Mississippi River. He knows basis tends to be its weakest in fall and strongest in May, when everyone’s doing fieldwork. During the last three years, it’s been worthwhile for Oberbroeckling to pull the trigger on basis whenever it hit 20 cents under futures or less. He’s already locked in some basis on the 2019 corn crop at 19 cents under.

He says he could gain another 4 to 5 cents per bushel by waiting, but he’d be risking 15 to 20 cents if the market took a turn for the worst.

“If you see something that looks attractive, don’t be afraid to take a piece of it,” he explains. “A nickel, a dime or 15 cents better on basis, that’s a lot right now in a market that’s only moving 50 cents. It’s doing the little things. You’re not going to hit a home run by doing one of them, but getting a lot of base hits will get you around the bases and back to home plate.”

MANY WAYS TO GET ON BASE. For McDonald, base hits don’t just come from marketing; they come from diversifying the types of crops he grows and selling into as many premium markets as he can.

McDonald gradually began taking over farm operations from his father in 2011 and will be farming the majority of the acres this spring. One of his early decisions in 2013 was to transition one farm into organic corn, alfalfa and oat production. Organic corn prices are often three times higher than conventional. “It’s a lot more work, but at the same time, it helps out at the end of the year with prices,” he says.

Other ways he’s diversified: selling corn at a premium for whiskey production and growing non-GMO soybeans.

“There is a little bit of a premium--40, 50, 60 cents--which, in the grand scheme of things, isn’t a big thing,” he says. “At the same time, when you’re dealing with some pretty crappy basis over here in western Iowa, it helps.”

Oberbroeckling also grows non-GMO soybeans. He adds it’s another benefit to on-farm storage since you have to hold the beans until the buyer calls, usually the following spring.

JUST SAY NO TO FOMO. Fear of missing out (FOMO) on a price rally paralyzes some farmers. McDonald and Oberbroeckling say the key is knowing your breakeven, even if it’s only an estimate.

Oberbroeckling suggests looking at average input costs during the past couple of years to help determine your expenses, as well as using a five-year average yield. If you know the price of one or two inputs will be drastically different than in the past, or if big capital expenditures are coming, include those, too.

“You’re not going to hit everything perfect, but you’re going to be within 10% without trying too hard,” he says. Many farmers can get even closer. While it’s an imperfect science, McDonald says you can always update your price targets for future sales.

Start With a Plan. “I would tell producers, the biggest thing you can do is make a plan. Set your prices, whether it’s your break-even or your goal price, and stick to those prices,” McDonald says. “I can’t tell you how many guys get mad when they don’t stick to those prices.”

DTN’s Hultman says it’s important to take advantage of price opportunities when they come, especially when they’re seasonal. He stresses not to get caught in the trap of thinking the market will keep moving higher.

“You have to ask yourself: ‘Why aren’t you selling at least half your crop when you see these opportunities?’ ” he says. “In corn and soybeans, the seasonal high and low has been fairly consistent over my whole lifetime. There’s not too many things you can say have worked in the market over 50 years. The seasonal influence in corn and beans is one of them. It’s hard to outthink that.”

Be Prepared for Margin Calls:

Some farmers hate margin calls, but farm manager Erik Oberbroeckling cheers for them. It means the market is going up, and you can sell your grain at a better price.

He explains having a separate line of credit for hedging instead of relying on your operating note takes the emotion out of margin calls. Instead of worrying that you’ll max out your operating loan and have to liquidate your hedges, “you know that money is there, and that’s what it’s there for.”

Oberbroeckling included his broker in his initial conversations with his banker about setting up a hedging account. He had to educate his banker on what he wanted to do, why he wanted to do it and the potential risks of his strategy.

In the end, it came down to good communication and trust. “The banker has to have enough trust in the farmer that the farmer’s going to run it the way he advertised it and not turn it into a speculation account instead of a hedge account,” he says.

Options Basics:

Buying a put gives you the right, not the obligation, to sell the underlying commodity at a certain price at a certain time. For example, a $3.50 December corn put expires at the end of November. If the December corn futures price is lower than the strike price, you can sell futures at the higher $3.50 price. If futures move higher, you are not obligated to sell at the lower price.

The seller of the put receives the premium in return for accepting the risk that he may need to buy a futures contract at a price higher than the current market. While that can be a risky position, the premium received can help offset the price of buying a put.

Buying a call gives you the right to buy the underlying commodity at a certain price. When prices move upward, the owner can exercise the call option and buy futures at below market value. If futures move lower, the call buyer is not obligated to buy at the lower price.

If you sell a call option, you collect the premium but will be obligated to sell a futures contract at below-market prices.


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