As we approach our next fall harvest season, the yield potential seems very much unknown.
We can find prognosticators telling us of way-low national yield and we can find as many others telling of trend yield or above. We will know for certain shortly.
Until then — I am asking farmers to consider the risk of price movement.
Row crop farmers are challenged by several sources of risk. These sources of risks include production, price, finance, legal, environmental, health, and government policy.
The focus here is marketing risk. “Market Risk” is translated into English as — the risk that prices will fluctuate.
We plant a crop expecting a harvest and from our perspective — a rising commodity price is good. Declining prices, prices below break-even and price uncertainty are often viewed as not-good. This is price risk.
Farmers have several tools available for use as choices when contemplating managing price risk. The most common tools are cash grain contracts, futures contracts and option contracts.
Additionally, the most significant and basic opportunity for managing price risk is the proper use of a revenue-based crop insurance product.
The concept behind managing price risk is to establish a “safety net”. This safety net is intended to minimize the potential for financial loss.
One important point to recognize is that minimizing the potential for loss usually comes at a cost. We must pay for our price risk management tools. Many farmers combine tools to achieve a balanced approach to price risk management.
Consider several marketing opportunities from cash sales to forward contracts to futures and options. Basis information for your local market is necessary to analyze the futures and options marketing alternatives.
The result of considering all marketing alternatives is to arrive at expected prices for all marketing alternatives. These expected prices can be compared with the cost of production.
Whether the current expected prices exceed or are less than the total cost of production, the decision becomes one of marketing a certain percentage of expected production now or taking a risk that a higher price can be obtained at a future date.
• Forward contract;
• Sell futures contracts;
• Hedge-to-arrive contracts;
• Buy put options;
• Forward contract and buy call options;
• Getting fancy with options: selling calls to form a price window;
Remember, profit is a return to risk. You cannot reduce all risk and still expect to excel in profit. This may be a good time to seek out some additional educational opportunities intended to build our marketing skill set.