Have you thought about selling insurance? (Grain Marketing)
(Editor’s note: Rob Davis is a market advisor with Nagel Farm Service.)
No, I’m not talking about getting a job off of the farm.
I’ve always admired people that have figured out a good side-hustle — but that’s not usually an option for farmers. Farmers never punch-out and managing a farm is like a collection of side-hustles — delivery service, mechanic, bookkeeper, grain marketer.
It’s difficult to recommend a grain marketing strategy broadly, as every farm operation is different.
That being said, I think it’s safe to assume that this year will likely be financially difficult for most farmers. What was once a steady flow of corn into ethanol plants and then eventually into American automobiles has become a massive pileup of corn.
Cars are stopped, many ethanol plants have been mothballed or closed permanently and the May corn contract has been t-boned – falling from nearly $4 in January to a low of $3.00 1/4 on April 29.
On May 14, the July corn contract closed at $3.17 1/2 and the December corn contract closed at $3.31 3/4.
Outside of having a major drought across the corn belt this year, we know that we will be staring at a massive over-supply of corn this year, come harvest time.
One strategy that we’ve deployed with farmers a good bit over the past few years has been similar to a call-writing strategy.
In most cases, we’ve tried to simplify the strategy for farmers — as a building block within a structured contract, also known as an accumulator. We’re trying to keep this required side-hustle of “grain marketer” time and cost efficient!
Using a call-writing strategy requires the writer (seller) of the call, to give away upside above a certain level (strike level) and in return they collect options premium.
This can be a risky strategy if you are writing a naked call, which means that you don’t own the actual asset (for example, corn).
If you own the asset (farmers own lots of corn), it becomes a conservative strategy — covered call writing.
One word of caution here: Many farmers will tell you about that one time that they traded options and got a large margin call — and they don’t want that headache again.
I can understand! This happens because the that they wrote is losing value in an options account and the offsetting asset that is gaining in value, is the corn out in the field. The issue is that the broker can’t put corn in a brokerage account — from their perspective — it looks like a naked call.
This is where the bank can help, but at this point the farmer is usually really annoyed that this grain marketing side-hustle is costing him so much money that he’s having to go ask the bank to increase his credit line to pay for losses in their account.
One way to avoid margin calls is to let your elevator deal with it, in the form of a structured contract.
The covered call strategy is very similar to having a double-up condition in a structured contract.
A big difference is that instead of a large margin call, you are assigned an additional grain contract (usually referred to as being “doubled-up”).
The grain buyer deals with cost and headache of margin calls, which is offset by the potential for buying additional bushels.
Now that I’ve thoroughly bored you, I’ll get to the point about selling insurance.
Initially, most people (myself included), have a tough time wrapping their head around put and call options. To make this call writing strategy a little easier to understand, you can think about it like selling an insurance policy to a corn buyer like a poultry company.
If they wanted an insurance policy that would guarantee that they will not have to pay more than $3.70 per bushel for corn this fall, they could go directly to farmers offering them a 10c premium for that guarantee. Essentially, the same strategy could be accomplished in the options market – you can collect about 10c today by writing (selling) a 3.70 strike December corn call.
This is the foundation for a lot of the strategies that we’ve recommended recently, helping farmers sell upside potential on future years in an effort to help the bottom line in a year that we expect to be characterized by low corn prices.
On May 14, the July soybean contract closed at $8.37 and the November contract closed at $8.43 3/4. The July wheat contract closed at $5.02 1/4 and the July 2021 wheat contract closed at $5.23 3/4.
(Rob Davis is a market advisor with Nagel Farm Service. He can be contacted at Rob@nagelgrain.com or 410-822-6300. Nagel Farm Service has been serving farmers since 1946 and offers Grain Merchandising, Crop Insurance and Risk & Profit Consulting services throughout the Mid-Atlantic region).
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