What is in this article?:
- Knowing marketing options can limit price risk
- Requires more cash-in-hand
• There are numerous methods that one can employ to help limit price risk as a seller or a purchaser of a particular commodity.
Requires more cash-in-hand
Others may use the commodity futures market and hedge their crop on one of the boards of trade or exchanges. This usually requires more cash in-hand for use as margin calls that may be required while you are holding on to the contract prior to either making deliver or taking delivery of a commodity.
Sometimes this amount of money being held as a margin can be substantial, but so can the benefits if a producer uses the correct methods to employ such price risk management strategies.
The commodity futures markets were developed specifically for farmers for the sole purpose of locking in a price for their product. This way they knew what their commodity or product would receive as long as they delivered the product on time, at a specified location, of a certain quality and quantity.
A very close alternative to hedging is the hedge-to-arrive option offered by most elevators. It works exactly like a hedge other then you must deliver to that elevator. However, you are not responsible for the margin calls, the elevator covers those for the promise of delivery.
Due to the cash that may be required to hedge a commodity on one of the exchanges or boards of trade, many producers find this unsettling and may utilize the option market as insurance against or for price movement.
This can have minimal cost in comparison to other techniques, but does not necessarily lock in or guarantee a price for a commodity, but more closely acts as insurance for the holder of the option and provides an opportunity or option to enter the market if commodity prices hit a specific mark.
It is never too early to begin a good price risk management strategy. In fact, much of a crop may be marketed prior to it even being planted.
For further information, you can read the pricing tools lecture notes.
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