More Corn, Less Beans?

The first "official" look at new crop acreage will come with USDA's March 31st Prospective Plantings Report. For several months, market analysts have concluded that corn acreage will increase and soybean acreage will decline for 2003 crops. Pre-report estimates, among analysts, predict that corn planted acreage will exceed 80 million acres (several estimates are near 81 million acres), all well above last year's 79.1 million acres. While uncertainty about spring wheat acreage exists, most expect soybean plantings to be less than last year's 73.8 million acres with estimates from 69.5 to more than 72 million acres. These expectations grew out of last fall's higher grain prices, amount of fall tillage and fertilizer application along with new farm legislation provisions that lowered soybean loan rates. But what about higher fuel and fertilizer prices along with disappointing corn demand and sagging prices? Are the markets sending any signals? Will producers really plant more corn and what last-minute changes should Missouri farmers consider?

The soybean/corn price ratio is often used as a signal for whether the markets want more of less of one crop compared to the other. Historically, ratios of 2.4/ or 2.5/1 (soybean price/corn price) have been considered the breakeven range. Ratios above 2.5/1 favor soybeans and ratios less than 2.4/1 favors corn. For Missouri producers this ratio may be lower (possibly 2.2/1 or lower) since Missouri soybean yields are believed to be more competitive than corn yields compared with other major corn producing states.

During late fall of 2002, new-crop soybean (Nov '03) futures prices were around $5.10 and corn (Dec '03) futures prices were near $2.44. This is a soybean/corn price ratio of 2.09/1 and signaled the markets favored corn. This, along with fall field preparations, suggested more corn and fewer soybean acres in 2003. Recently (3-20-03) November soybeans were about $5.16 and December corn was near $2.36 for a ratio of 2.19/1, still appearing to favor corn. But does it really?

Most analysts point out that when prices drop below government loan price (Soybean-$5.00, Corn-$1.98) these prices begin to favor soybeans with a ratio of 2.52/1. Assuming harvest time basis patterns similar to recent years, many locations in Missouri would offer cash soybean prices thirty-five cents under the November futures price and cash corn prices at least thirty cents under December futures. This would produce new crop soybean cash bids (using the above new crop futures prices) of $4.81 and cash corn bids near $2.06. However, before using these prices to compute a ratio, remember that the LDP actually supports soybean prices near loan price or $5.00. These new crop futures prices actually produce a soybean/corn price ratio of 2.43/1 ($5.00/$2.06) or within the break-even range between the two crops. As new crop corn prices approach loan price, the balance begins to shift more toward soybeans.

Regardless of what USDA's Prospective Plantings Report says, higher fuel and fertilizer prices along with production and price risk suggests maybe Missouri producers should consider planting soybeans on land not already committed to corn. This argument is reinforced by a new crop soybean/corn price ratio that is beginning to favor soybeans-especially for Missouri producers.

Options Provide Risk Management Flexibility

Relatively tight grain supplies, export uncertainties, weather concerns and a variety of other factors create a high-risk environment for new crop pre-harvest sales decisions. Do you risk making early season sales to take advantage of seasonal opportunities to avoid bearish scenarios that see harvest time corn prices under $2.00 and soybeans in the low $4 range? Or do you risk waiting too long in hopes of bullish outlooks that project the possibility of $3.00 corn and $6-plus soybeans? Using commodity options can provide methods to manage these risks associated with "selling too early" or "waiting too long."

Buy a Put:

One relatively simple strategy is to buy a put option to capture early season price opportunities, while avoiding some of the risk of selling too early. This strategy establishes a floor price. The put gives you the right to sell futures at a specified price (strike price). If prices decline, exercising the put allows you to sell futures at the strike price and places you in a futures hedge position on your grain. A more common alternative, since as prices decline and the right to sell at the strike price becomes more valuable, is to sell (liquidate) the option and pocket the gain. Gains from the option or the futures position offset the cash price decline on your growing crops and the net price is near the original option strike price minus the brokerage charges and local basis. If prices increase, the option may be liquidated or allowed to expire worthless and the grain sold or contracted at a higher price and you will only be out the option premium.

The disadvantage to this strategy is the cost (premium) of the option. Often, new crop prices are discounted to old crop prices at this time of year. The lower futures price and resulting option strike price, minus what are sometimes expensive option premiums along with a weak harvest time basis results in a disappointing expected net price. What is often overlooked is the fact that, if prices continue to decline, the actual harvest time price may be even more disappointing!

One method of reducing the net premium cost of a put option is to use a bear put spread. This is accomplished by buying a put option at a strike price near the current futures price (at-the-money). You then sell (write) an out-of-the-money put option (one that has a strike price below current prices). The money your receive for selling the out-of-the-money option offsets part of what your paid for the original option, reducing the net premium you paid. The disadvantage is that this strategy doesn't completely establish a floor price. If prices decline below strike price of the option you sold, you will be obligated to perform and those losses will offset the additional gains on the original purchased option. However, your net "hedged" price will still be greater than if you had done nothing. If prices increase, both options expire and you sell your grain at the higher prices.

Offset early pre-harvest sales (hedges) with a call option:

If you choose to take advantage of early pre-harvest prices by making cash contract sales or selling futures to hedge, you can avoid some of the risk of selling too early with the purchase of call options. Buying a call option provides the right to purchase futures at the option strike price. If prices increase, you may exercise the option or collect premium gains to offset the higher prices you missed with the cash sales or futures hedges. If prices decline, you have made good early season sales or hedges and you can let the call option expire and only be out the option premium. One advantage of this "insurance against missing higher prices" strategy is that you can get it with a "deductible." This can be accomplished by buying an-out-of-the-money (higher strike price than current futures price) call option. You give up some of the gain from current prices to the higher strike price, but save on premium cost and can still capture some of the much higher prices that might occur in a weather scare.

Write (sell) a "covered" call option:

To use this strategy, you set a price goal (above current prices) that you would be willing to hedge (sell). At this price (it will have to be an option strike price) you sell (write) a call option, allowing you to collect the option premium. If prices increase to the point at which the option buyer exercises the option, this means you are obligated to sell futures at this price. However, this is a price that you have chosen as an acceptable price and by selling the futures you have now hedged your un-priced production. You also have received a premium and this is added to your net-hedged price. For example, suppose December corn futures are currently $2.40 and you sell a $2.60 (strike price) call for a premium of ten cents. If December futures go to $2.60, you sell futures at $2.60 (hedging your new crop corn) plus you have the ten-cent premium making your hedged price $2.70 minus your local harvest time basis. If prices decline ant the option expires, you have collected the premium, which is added to the eventual selling price of your grain.

These option strategies when used with other marketing tools can make selling decisions easier. They enable you to avoid some of the risks associated with selling too early or waiting too long, while establishing what may be a favorable price.