The difference between success and failure in business is how well that business is able to manage risk. This special issue of The Progressive Farmer provides ideas for managing risk in one of the most volatile times ever in agriculture.

Maneuver Through The Market Maze
Rapid changes in commodity prices are causing growers to alter
their marketing plans.
By Des Keller

In addition, the VanTilburgs have had to cope with the loss of their primary banker. This came at a time when they, like many producers, were borrowing more money than ever in part to protect grain sales on the Board of Trade in a highly erratic market. The VanTilburgs and their sons have since found a new lender.

As for the grain from their family farm, the VanTilburgs have generally pre-sold (prior to harvest) most of their production. "We don't hit many home runs doing it that way," says Jim, "but this keeps us in the ball game."

Unfortunately, most people haven't been able to use cash forward contracts to sell 2009's production. "Terminals aren't even bidding out that far," says Brenda, who leads the operation's marketing efforts. (The ability to make forward contracts for 2009 production reemerged late in 2008.)

For years, terminals and grain elevators have used futures and options to protect themselves on forward cash contracts. But now they can't afford the risk.

Neither can farmers. They don't want to be exposed to potential margin calls, and many don't want to pay the premiums for less expensive options on futures.

Sound strategy. "In the past we locked in a profit through forward contracting then took out what we called a 'stay in the market' option through the Chicago Board of Trade," says Brenda VanTilburg.

For example, if they forward contracted some 2008 corn production in September at $5.50 per bushel, then they might have taken out a call option for $5.50 per bushel until March 2009.

If the price of corn went to $6 before March, you would exercise the call and pocket the difference between $5.50 and $6—minus the approximately 25-cents-per-bushel premium for buying the calls. If the price goes down, you are just out the premium paid for the options.

"We've generally found that's a cheaper way to do it than to put the grain in storage and wait for the price to go up," says Brenda. "It's a lot more challenging now (to know when to execute a marketing plan) because of higher crop expenses."

Dan Basse, president of Chicago-based AgResource Co., estimates higher costs for 2009 mean producers in Illinois will spend about $540 per acre to plant corn. Given these costs and the general market outlook, he contends there's "no reason to make forward sales."

"There will be plenty of opportunity and situations that allow grain prices to reach lofty levels in the years ahead," says Basse. "It would take something fairly dramatic—a bird flu pandemic or a complete political elimination of the ethanol industry—to alter the [long-term] bullish landscape for grains."

Not surprisingly, Basse's optimism was even greater before the financial crisis hit and commodity prices dropped. Still, "this volatility will present several marketing opportunities," he says.

That is good news for Mike Allyn of Mount Vernon, Ind., whose family farms about 5,000 acres. "I don't know any farm that can be financially stable and be able to hedge their whole crop on the Board," he says. "That would take an unbelievable cash flow."

For now, the Allyns will continue to make cash sales to a local elevator. They will also benefit from two area ethanol plants scheduled to begin operations in the first half of 2009.

As with several other producers interviewed, the Allyns hope to be paid by the ethanol plants to use their storage facilities.

Up until three years ago the Allyns used hedge-to-arrive contracts for much of their production. Volatile, atypical swings in basis numbers since then forced them to phase out the contracts.

Other strategies. It is possible to take advantage of increases in crop prices while protecting the downside, using various futures and options strategies, says Bill Biedermann, senior vice president of Allendale Inc. in McHenry, Ill.

As an example, he used the Oct. 17, 2008, corn close of $4 per bushel. Biedermann assumes the producer has 2,000 acres of corn that yield 195 bushels per acre (390,000 bushels).

Using one of Allendale's programs that details various hedges, you could buy put options (an option to sell grain in the future at a given price) at $4 per bushel. (See "A put option exercise.") You would purchase 78 put contracts to cover your production at a cost of 24 cents per bushel. Your cost or premium for the options is $93,600.

That is a lot of money, but if corn prices decline below $4 at the expiration of the put hedge you can still "exercise" the put at $4. If the price goes to, say, $7 per bushel, you merely let the put hedge expire and sell the grain for more.

Under that scenario, the net gross revenue per acre (minus interest, commission, basis and the cost of the options) would be $1,254.94.

This is the kind of a plan your lender can approve because the worst-case scenario is known, according to Biedermann.

Market comments from DTN's Darin Newsom appear each Wednesday at about.dtnpf.com/markets