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Hedging Can Open Up Your Grain Marketing Options


by Hannah Tucker

Published: Friday, November 10, 2017

With harvest wrapping up, it's not too late for farmers to consider their 2017 crop marketing plans and look for ways to improve their returns. By understanding how cash and futures prices change over time, farmers can take advantage of seasonal patterns to improve the prices they receive for their grain.

The first step is to understand what basis is and how it changes throughout the storage season. Basis is the difference between cash and futures prices of a commodity at a specific location. During harvest, when supplies are large, basis tends to be very weak, meaning that local cash prices in northern Indiana and southern Michigan usually trade below the futures market prices. That's been the case this year as Indiana farmers finish harvesting large corn and soybean crops.

An easy way to track basis throughout the storage season is to compute basis off of a deferred futures contract near the end of the storage season. For example, if you're willing to consider storing until late spring, you could compute basis off of the July futures contract starting now and continue to track it until late June. When you look at this way, basis tends to increase throughout the storage season and generally reaches its peak sometime in late spring or early summer.

Storage hedging is a way to capture this expected increase in basis.

"A lot of farmers don't storage hedge, but it's something they should definitely consider," said Jim Mintert, director of Purdue's Center for Commercial Agriculture. "If you only pay attention to nearby futures, you might be missing the profit potential that exists."

Hedging means using the futures market as a temporary substitute for a later action that you'll take in the cash market. For example, if you harvest corn in October and want to sell the cash corn in May when basis is more positive, you can hedge by selling futures in October, and offset the futures hedge in May when you sell in the cash market.

Take recent cash corn prices in New Haven as an example. In mid-October, basis computed from July futures was minus 46 cents per bushel. Examining basis history for that location, we can estimate what basis might be in late May. Looking at the last three years, basis in late May averaged minus 8 cents per bushel A storage hedger can earn the basis improvement (in this case, it could be 38 cents per bushel), while not being exposed to the risk that futures prices might decline during the storage season. This is a much lower risk strategy than simply storing the grain unhedged.

The storage hedger locks in the futures price, which means you won't be exposed to futures price risk. However, hedging does not lock in basis, which lets you capitalize on the expected increase in cash price. But keep in mind that there is still some risk involved with speculating on basis.

"The concept of hedging relies on the fact that basis is relatively predictable," said Mintert. "But it's not perfectly predictable. There's some science to forecasting basis, and a little bit of art too."

But although basis isn't perfectly predictable, it's even riskier to speculate on futures prices. If you just store corn in the bin and take no action to lock in a futures price, you're exposed to both basis and futures price risk. By hedging to lock in the futures price, producers are speculating only on basis, making it a considerably less risky alternative.

The 2017-18 storage season is looking especially favorable for hedgers due to large supplies and weak basis levels this fall. And for the many Indiana farms that have on-farm storage, hedging is even more attractive.

"We came into this year with relatively large supplies," said Mintert. "Additionally, this year is going to be one of the largest crops on record. When you have large supplies, the market must effectively provide producers and the grain industry with an incentive to store. The relatively wide harvest basis, computed off of July futures, is providing a strong incentive to store."

Before deciding to hedge, producers should consider their storage costs and the investment they have in their grain over the storage period. On-farm storage costs are often significantly less than commercial alternatives, making the storage hedge even more attractive for farm operations with ample storage capacity.

As harvest comes to a close, consider storage hedging as a way to capitalize on the seasonal pattern of basis. For more information on this topic, consider attending Purdue's Top Farmer Conference in West Lafayette on Jan. 9, which will feature a detailed talk on basis and how to identify patterns that provide profit opportunities. For more information, visit Purdue.edu/commercialag.

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