Market Matters Blog 11/24 10:11
Is It Time to Build a Fence?
A "fence" strategy could help farmers take advantage of some of the
uncertainty during the next few months but still allows some protection to the
downside and a shot at higher prices.
Senior Market Analyst
Corn futures have now rallied more than $1.00 from early August lows and the
once very bearish outlook for new crop corn has changed dramatically. While the
once lofty ending stocks projections of 3.0 billion bushels (bb) to 3.2 bb of
corn in the spring have fallen by the wayside due to drought, derecho winds and
an insatiable appetite from China, perhaps it's time to consider a new
marketing strategy for recently harvested corn.
U.S. ending stocks are now forecast at 1.702 bb -- nearly cut in half from
springtime projections, but still a comfortable supply. In order to arrive at
that carryout, the World Agricultural Supply and Demand Estimates (WASDE)
report increased corn exports to a record large 2.650 bb.
Granted, China has come in and bought over 10 million metric tons (394
million bushels) of U.S. corn and some analysts think China could buy much more
by year's end. However, for the past few weeks, U.S. corn shipments have lagged
the weekly average needed to attain the lofty export projection; we have seen
some for unknown destination, but no new sales for China.
Price comparisons favor U.S. farmers and corn exporters, as both Brazilian
and Chinese internal prices just reached record highs while Ukraine's crop has
been decimated by dryness. As of Nov. 23, U.S. corn is cheaper than both
Ukraine and Argentina. The U.S. is well-positioned to garner much of the new
corn business in coming months, but there is no guarantee as to how much China
will buy or how South American weather will turn out.
With corn prices rising, farmers may have become reluctant to sell more corn
until they see if China buys more or if South American dryness continues. This
may be a good time to consider protecting the gains corn prices have made,
while still allowing room for upside gains. The funds maintain a dangerously
long position and long-term weather, as well as China, is hard to predict.
There is one marketing strategy that can take advantage of some of the
uncertainty during the next few months but still allow farmers some protection
to the downside and a shot at higher prices. It is referred to as a "fence"
strategy. In short, a farmer owns cash corn and buys a near the money put while
simultaneously selling an out of the money call. The strategy has a modest net
cost and limits downside risk, while offering more upside to a farmer's cash
As an example, take a look at May 2021 options, which don't expire until
April 23, 2021, or roughly five months from now. With May 2021 corn futures
trading at $4.36, a $4.20 put would cost 18 1/2 cents, while a $4.80 call is
valued at 16 1/2 cents. If a producer bought the $4.20 may put and sold the
$4.80 May call simultaneously, the net cost of that fence strategy would be 2
cents (debit). Let's assume that the basis for one location is 10 cents under
the May contact for spring delivery.
If a farmer does this on his own, at a brokerage firm, he will be
responsible to maintain the margin requirement, which could become substantial
if corn prices trade significantly higher. Talk to your local co-op or cash
grain firm, however, as many can offer the same fence strategy without putting
you on the hook for margin.
By executing the simultaneous purchase of the $4.20 put and sale of the
$4.80 call, the range of cash prices from worst to best would be $4.08 to
$4.68. The $4.08 reflects the $4.20 put strike price, less the 2-cent debit for
the option strategy and the 10-cent under basis, as the $4.20 put strike less
$0.12 equals $4.08. On the upside, the $4.80 strike of the sold call, less
$0.12 would be $4.68. I am assuming a farmer only enters a portion of his
unsold crop in the fence.
The net effect of the fence strategy explained above is that the farmer has
a chance to sell his/her corn at a maximum of $4.68 per bushel or is protected
with a minimum cash sale of $4.08 on the downside, assuming the farmer locks in
the basis at 10 cents under or that it doesn't change. That would compare to
the current cash price of $4.26 ($4.36 May futures less 10-cent under basis).
Rather than speculate on where the market might go with an outright long
cash position, this strategy protects much of the downside, while still
allowing more than 40 cents upside, for minimal cost.
Granted, if the South American drought worsens and production in South
America is threatened, and China does return to buy significant quantities of
additional U.S. corn, then surely May corn futures could exceed $4.80. However,
at this stage, that is mere speculation. If rains should come and China does
not appear, or if COVID-19 again accelerates to negatively impact demand, then
the overweight speculative long in corn could lead to a sharp correction.
This is simply a marketing idea, but if you are bullish to a certain extent
-- and you understand the downside risk -- then this might be a strategy for
you to consider on part of your recently harvested bushels.
Editor's Note: Comments above are for educational purposes and are not meant
to be specific trade recommendations. The buying and selling of livestock and
livestock futures involve substantial risk and are not suitable for everyone.
Dana Mantini can be reached at email@example.com
Follow him on Twitter @mantini_r
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