DECISIONS ARE NEVER EASY
Prepared by Richard A. Brock & Associates, Inc.
This past week's plunge grain prices serves as a reminder the importance of knowing how and when to make decisions. As always, it is helpful to have a decision-making framework available with an analysis of what can happen under different price scenarios when making decisions. That's what we're going to do in the corn market this week.
People Don't Change
Before getting to the meat of the story, one interesting report released this week by USDA is one that covers the marketing patterns of producers on a monthly basis in the grain market.
For example, in the major bull market of 1995-96 when corn prices peaked in July, in the top six corn states 44% of the crop was sold before the end of December 1995, 35% was sold during the January-March quarter and only 21 % was held after April 1. Even more important, during the major part of the bull market in July and August, only 3% of the corn crop was sold in Illinois, 6% in Indiana and 7% in Iowa.
Marketing strategies then changed quickly going into 1996-97. Since people sold early in 1995-96 and it didn't work, as you might guess, they stored into 1996-97. Only 34% of the corn crop was sold prior to the end of December, only 33% was sold in the January-March period and 33% was sold after April, most of which was sold in July and August where it was unloaded at the bottom.
This Year's Pattern Is No Surprise
Will this year be any different? Unfortunately, in talking with grain elevators around the Midwest, it appears this year's marketing pattern is running pretty much parallel with last year's in that very little grain has been sold so far. That's particularly concerning when you look at the numbers relative to this year's corn crop. Carryover supplies this year will be at least 953 million bushels, a significant increase over last year's 884 million and more than double the 1995-96 carryover of 426. With this level of carryover, the center of USDA's estimated average price is $2.60. We think that will be very hard to reach unless planted acreage drops well below expectations for this spring, combined with major weather problems. Therefore, let's look at some alternatives for both old- and new-crop corn. The tables will help.
Corn Selling Strategies
In old-crop corn, you can fill in the blanks with your own prices. We looked at four different strategies on old-crop corn: #1: Wait and sell the corn on the first week of August; #2: Sell the corn and buy Sep $2.80 corn calls to offset the sale; #3: Sell the corn and buy $3.40 September calls at $.10; and #4: Sell the corn now and do nothing!
Again, our table will help you sort out the answers. We are assuming a basis on August 1 of 15 cents under September corn futures. Therefore, if September futures dropped to $2.30 you'd net $2.15. If September futures are at $3.00, your net selling price for cash corn is $2.85. If you sell the corn right now at $2.66, assuming a 3 cent per bushel carry, that's the equivalent of getting $2.88½ cents for your corn in August. It would be even more advantageous if you are paying commercial storage.
In the options strategies, we used examples of buying an at-the-money call versus a “cheap” call at $.10. The cheap calls works better only because you lose less if the market goes sideways to down. Buying an at-the-money call works considerably better if prices blow through the $3.00 resistance.
The Bottom Line: With strategy #1, even Las Vegas wouldn't give you good odds. Holding corn and “hoping” that it goes higher clearly works against you unless the market moves sharply above $3.00 a bushel. You would have to strongly disagree with current supply and demand statistics to justify strategy #1. Frankly, at this price level this early in the year, it's hard to beat strategy #4–just sell it.
New Crop Is Another Story
Those of you who have been following us over the past few months know we have been very aggressive in selling new-crop corn. The bottom line is you have to be extremely bullish from this price level to justify not having at least something sold. Planted acreage is going to be increasing, and the negative impact of the Asian financial crisis will soon (if it hasn't already) be hitting the markets; history shows that selling corn over $2.50 at harvest time has in most years been a very favorable sale.
More specifically, take a look at our four strategies and I think you will see why we have split some of our decisions between selling December futures and using an options strategy of buying December $2.90 puts and selling December $3.20 calls. The results are in cash prices after deducting a basis of 20 cents under December futures. Strategy #1 is relatively simple. You just wait and sell next December and you will get 20 cents under wherever December futures are trading. If the market is trading at $2.20, you will receive $2.00 per bushel.
Strategy #2 is also pretty straightforward. This particular individual can forward contract grain for November/December delivery to his local elevator today for $2.68. It makes no difference where the market goes–he's going to get $2.68.
The same is true for strategy #3. The key difference between #2 and #3 is that in #3 if the market dropped to $2.20 and the individual thought the market would come up from there, he could buy back his futures contracts at $2.20, net $.48 cents per bushel and then ride the market up. The disadvantage #3 has is of course he has to emotionally be involved with margining his futures account.
While strategy #4 looks complex, it isn't. As I write this, you can buy December $2.90 puts at $.24 cents per bushel and sell the $3.20 calls for $.14, a net cost of $.10 per bushel. That means that going into expiration if December futures is trading at $2.90 or lower, the worst net futures price you are going to receive is $2.80. When you deduct your $.20 basis from that, the floor for your cash market becomes $2.60.
The nice aspect of this particular strategy is that if the market goes up you can still enjoy a ride up to $2.90 per bushel. Why? Because since you are short the $3.20 calls and unless the market is above that level at expiration, you are still out only the $.10 per bushel for the cost of the options strategy. In essence what you have done with Strategy #4 is place a floor in your cash market at $2.60 and a ceiling of $2.90. That's something everybody should be able to live with.
December 11, 1997 Richard A. Brock & Associates, Inc.
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