DairyBusiness

by MATT MATTKE

Selling Futures Against Bought Corn

Corn feed buying agreements should be simple, flexible and give both parties greater control over the price paid or received. One simple feed contract for both the dairy producer and corn grower is a “pick your price” contract. The corn grower simply decides when he wants to lock in his sales price with the dairy producer. Depending on the time of year and the corn grower’s market savviness, that time could be an ideal buying opportunity for the dairy producer, or it could be the most inopportune time.

Example

The following example assumes the corn grower picks a very inopportune time for the dairy producer to buy corn.

Suppose the corn grower decides to sell 30,000 bushels of corn to the dairy producer at $4.50/bushel. It is April, seasonally a stronger month for corn prices.

The dairy producer believes a better buying opportunity will come in a few months, so he wants to neutralize that $4.50/bushel  purchase price and be positioned to lock in a lower purchase price if the market offers the opportunity.

Therefore, immediately upon agreeing to the $4.50/bushel purchase price with the corn grower, the dairy producer turns around and offsets that price by selling 6 futures contracts (5,000 bushels per contract) in his hedge account at $4.50/bushel off the December futures contract. By selling those futures contracts, the dairy producer has reopened his opportunity to capitalize on lower corn prices. However, this also means he has simultaneously reopened his risk to have to pay higher corn prices. Ultimately, the dairy producer is back to taking the open market price until the futures contracts are exited.

In the table below, the first column shows a scenario where the corn price drops to $2.00/bushel. Under that scenario, the dairy producer capitalized on $2.50 of additional downside opportunity by having the sold futures in place. The sold futures netted him $2.50/bushel and, by subtracting that gain off the $4.50/bushel cash price established by the grower, yields a final purchase price of $2.00/bushel (not including commissions and fees from placing the hedges).

The last column of the table shows a scenario where the corn price explodes to $8.00/bushel. Under that scenario, the dairy producer realized $3.50 of upside risk by having the sold futures in place. The sold futures netted him a net loss of $3.50/bushel, and by adding that loss to the $4.50/bushel cash price, yields a final purchase price of $8.00/bushel (not including commissions and fees from placing the hedges).

The other two examples shown in the middle columns of the table show a more modest price appreciation scenario and a more modest price decline scenario.

Bottom line, the table illustrates that by selling futures against a purchase price established by the corn grower, the dairy producer is ultimately back to taking the market price until the sold futures are exited. Whatever price the sold futures are exited at is the final price paid by the dairy producer for those 30,000 bushels of corn (not including commissions and fees from placing the hedges).

Disadvantages

The disadvantage of selling futures contracts against cash purchased corn is the futures remove the ceiling price established by the cash purchase contract. The other disadvantage is having to finance any margin calls generated by the sold futures contracts in the event the corn price goes higher.

Advantages

The advantage of selling futures contracts is the flexibility it gives the dairy producer to manage his price risk on that corn, while still maintaining a contract with the grower for the physical bushels. The other advantage is the dairy producer is providing the corn grower the same type of pricing mechanism he could get at the local elevator. For many corn growers, having the ability to set his sales price with the dairy producer may make the dairy producer a more attractive market to go to than the elevator.

The next article will cover the strategy of buying cash corn and protecting that feed purchase with a fence position.

FYI

■ Matt Mattke, Market360® adviser at Stewart-Peterson, can be reached via e-mail: mmattke@stewart-peterson.com, phone: 800-334-9779 or visit www.stewart-peterson.com.

Table 1. Corn price direction scenarios and impact on price dairy producer pays for corn ($/bushel)

What if the corn price goes to:            $2.00         $4.00             $6.00               $8.00

Price of sold futures contracts:           $4.50          $4.50             $4.50               $4.50

Gain or loss of sold futures**:              $2.50          $0.50            ($1.50)            ($3.50)

Price locked in with corn grower:       $4.50          $4.50             $4.50              $4.50

Final price locked in

after sold futures gains or losses

($4.50 minus gain or loss)**:               $2.00           $4.00             $6.00              $8.00

** Commissions and fees with placing the futures trades is not included in these examples, but must be factored into final gain and/or loss of sold futures positions