Guest - Dan Manternach
Dan Manternach is a seasoned, independent agricultural economist, speaker and author. A graduate of Iowa State University, Dan was raised on a diversified grain and livestock farm in northeast Iowa. During his 40-year career, he has been an executive with four of the top ag market advisory services in the U.S., served as part-time adjunct instructor in futures and options trading for commercial risk management at the University of Northern Iowa, and provided consultation to the U.S. Grains Council on a trade mission to China. Dan has extensive experience offering risk management counsel on major field crops, hogs and cattle. He leads grain marketing seminars, courses and lectures across the Midwest.
May 15, 2018
During the past 20 years or so, a host of new types of marketing contracts have been offered by major grain companies or professional marketing advisory services. In fact, new ones are still being developed and offered today. All fall under the umbrella of what’s called “new generation contracts” (NGCs) because they are more than just new tools: they involve new decision-making processes and even new decision-makers operating on behalf of farmers who decide to outsource the marketing of at least part of their production to professionals. Traditional marketing strategies involve discretionary sales by the farmer, sales the farm makes on the advice of an advisory service, or some combination of the two. AgMAS Conducted the First Landmark Study of NGC Performance AgMAS is an acronym for Agricultural Market Advisory Services. It was formed at the University of Illinois and its initial mission was evaluating performance of all major market advisory services during a 10-year period from 1995-2004 by crop or livestock category. The team of six AgMAS ag economists also did a landmark study of comparative performance of various NGC products in 2003. They first established the three different categories of NGCs that have since become widely accepted: 1. Automated Pricing Contracts follow predetermined, non-discretionary pricing rules designed to market a given quantity of grain at regular intervals over a period of time to achieve the average price during that period. If the prices locked in are futures prices, then setting the basis is typically left to the farmer. While selling at regular intervals is not a complicated strategy and could easily be done by the farmer, the automated contracts take the emotional element out of such decisions and the discipline to adopt such a plan is effectively on autopilot, as some might say. 2. Managed Hedging Contracts price a contracted volume of production on the recommendations of farmer-selected advisory services over a defined period of time known as the pricing window. The farmer may set a minimum selling price, but there are no guarantees in these contracts that even the average price will be achieved. The only recourse a farmer has, if he or she is dissatisfied with the pricing performance, is to pick another advisor in the future. 3. Combination Contracts combine elements of the first two types. They price the enrolled grain in the cash market under automated pricing rules, but also allow the farmer to share in any added gains achieved in futures hedging (if any) by the producer-selected professional advisor. In some such programs, a producer can enroll differing quantities of the same crop among several participating advisors to spread the risk of choosing the best advisor. NGCs Help Meet 4 Common Grain Marketing Challenges According to a 2007 study entitled "New Generation Grain Contracts" published by Dr. Steven D. Johnson , Farm Management Field Specialist at Iowa State University Extension, these challenges include: Inability to “pull the trigger” on sales for fear of pricing too much too soon Excessive emotion in volatile markets that leads to indecision The complexities from a variety of traditional marketing tools involving the farmer directly in trading futures and/or options Lack of discipline following a marketing plan and simply set price targets higher instead The views expressed in this article are the author's alone and not those of Farmer's Business Network, Inc., its affiliates or members.
May 10, 2018
There are, primarily, three different types of market risk you can face in choosing the wisest marketing tool for the job at hand. They are: Futures market risk Basis risk Opportunity risk Futures Market Risk Whether you have a futures trading account or not, your primary price risk is in the futures market because every other marketing tool available to you is tied either directly or indirectly to changes in futures prices. For that reason, futures risk is the one type of risk that’s generally the same for everybody; it is, in many ways, the common denominator among all buyers and sellers, whether they make their own trades or do so indirectly through other marketing tools available from their grain merchant. Basis Risk Basis is the difference between the local cash market price and the relevant futures contract. A premium basis is one where the difference is positive, for example, a cash bid in excess of the futures price. A discount basis is a cash bid that’s below the board price. A normal basis is the term given to a multi-year average of local basis for any given time in the marketing year. A basis is said to be unusually strong if the cash bid is at a larger premium or smaller discount to futures than normal for a given time of year in a given region of the country. A basis is said to be weak if at a wider discount or smaller premium than normal for that area. Local basis varies substantially from region to region across the country and even by time of year in different parts of the country. For example, local basis at facilities dependent on barge freight nearly always deteriorates when the nation’s inland river system freezes and grain transportation becomes limited to the more expensive modes of rail or truck. The 3 Key Drivers of Basis Are Typically: Distance and transportation cost to the nearest designated warehouse accepting grain for delivery in fulfillment of futures contracts The current balance of supply and demand at the local level Current “carry” in futures markets (progressively higher bids in deferred contracts to help cover costs of storage) Opportunity Risk This is one of the least recognized risks faced by both buyers and sellers, but manageable using certain marketing tools. It’s best explained by noting that a producer faces risk on 100 percent of his/her production throughout the year, regardless of what portion of that production is already priced. Similarly, a buyer faces risk on 100% of his/her grain needs throughout the year, regardless of what portion is already covered (purchased). Why? Because for both buyers and sellers, there is also the risk of lost opportunity, either by pricing too much too soon if a seller or buying too little too late if a buyer. The shrewd buyer or seller will consider accepting this and look for ways to manage all kinds of risk at any given time. The views expressed in this article are the author's alone and not those of Farmer's Business Network, Inc., its affiliates, or members.
May 02, 2018
If you're now well-versed in "the bar chart basics" of technical analysis to follow the ag commodities markets, the next step is to better understand a few of the pro tips to navigating the technical side of the grain markets. And how to think of them a little differently. Here's how technical studies - a common approach used by advisors serving farmers - can help you to follow the grain markets more closely. A technical study will typically fall into one of three basic categories: A component or measure of futures action, such as volume, open interest or Commitments of Traders reports (published by the Commodity Futures Trading Commission), that is displayed graphically, but separately below the chart and on the same time scale as the chart itself (daily, weekly or monthly). A separate mathematical calculation derived from price action and displayed as a line graph superimposed over a chart for comparison with an actual price trend. A separate mathematical algorithm or oscillator derived from price action, but displayed graphically and separately below the actual price chart. view; the monthly chart a 50,000-foot view. A TECHNICAL STUDY VARIES SIGNIFICANTLY FROM CHART ANALYSIS in that it is not a formation identified on the price chart. Instead, it is a separate calculation displayed graphically and superimposed over the chart itself or below the chart. BUT, THERE ARE ACTUALLY DOZENS OF DIFFERENT TECHNICAL STUDIES . Some work better than others in different types of markets, such as highly volatile markets versus markets in choppy, directionless sideways trends. Some work better for short-term trading, such as day-trading, while others work better for longer-term position trading. Some technical studies are even better suited to some types of traders. Some professional technicians will say that while their field is rooted in math, it can be more art than science. THERE ARE FIVE POPULAR TYPES OF TECH STUDIES used by professional advisors serving farmers. These studies have proven, over time, to be the most commonly referenced among market consultants to agribusiness: 01. Moving Averages Moving averages are exactly what the name implies: line graphs showing the average closing price over a specific number of days. How many days varies with whether the trader is wanting to identify short, medium or long-term price trends. There are moving averages plotted for as few as three days or as many as 200 days. 02. Moving Average Convergence/Divergence (MACD) Conversationally, it is sometimes referred to as the “Mac-D.” It is comprised of two exponential moving averages that help measure the momentum of a trend. The first component is the difference between these two EMAs, plotted against a centerline that is defined as the point at which the two moving averages are equal. The next component is the EMA of that MACD line, also plotted on the chart. In simpler terms, you might think of MACD as a derivative of price-based moving averages. Experts in MACD say to think of it as a derivative of price-based moving averages. 03. Relative Strength Index (RSI) The standard RSI calculation uses 14 trading days as a basis. It operates within a defined range from 0 to 100 and identifies overbought conditions (selling zones) when above 70 and oversold conditions (buying zones) when below 30. 04. Stochastics The stochastics oscillator is another widely followed momentum indicator. It operates on the idea that prices should be closing near the highs of daily trading ranges during healthy uptrends, and toward the lower ends of daily trading ranges during entrenched downtrends. Like the RSI, the stochastic oscillator is also plotted from 0 to 100. Readings above 80 are considered overbought, while readings below 20 are considered oversold. Any reading between 20-80 is considered a sort of “no man’s land,” neither overbought or oversold. 05. Fibonacci Retracement Theory Among the most common and challenging questions for hedgers and traders alike is when a major top following a long uptrend, or a major bottom after a long downtrend, has finally been confirmed. They might ask themselves... “How much of that big uptrend will the market ‘retrace’ on the way down, now that it’s over?” “How much of that big downtrend will the market now ‘retrace’ on its recovery?” These questions, or ones like them, can be traced back in history as far as markets have had records and charts. But the answers to those questions were discovered by an 13th century Italian merchant named Leonardo Fibonacci, who also happened to be a mathematical genius. He discovered numerical sequences in nature that had applications in market scenarios as well. They became known as “Fibonacci ratios” or simply “Fibonacci numbers.” The modern era of technical analysis originated in stock market studies and many of the same principles and studies have relevance in commodity futures as well. There are many sources of education on technical analysis - don't shy away from those that focus on technical analysis of stock prices to help you improve your approach to grain marketing. The views expressed in this article are the author's alone and not those of Farmer's Business Network, Inc., its affiliates or members.
Apr. 25, 2018
Because there are so many variables in supply and demand for ag commodities globally, it’s no easy task for the laws of economics to precisely balance supply and demand from year to year. Instead, mankind relies on market signals to either slow usage and stimulate production via higher prices or encourage consumption and discourage production via lower prices. Throughout nature and human history, we have observed cycles, or the tendency of certain events to repeat themselves at regular, fairly predictable intervals. There’s the 24-hour day/ night cycle; the monthly moon cycle, the yearly changing of the seasons, and the ebb and flow of tides. When it comes to grains, the fundamental "thermostat" guiding traders is typically the projected ending stocks for a given commodity in days of supply at the current rate of usage. This is a good proxy for the risk of running out before the next crop is available. When projected stocks fall below minimum pipeline requirements, the risk of running out rises and prices rise with it to slow the rate of usage. When projected stocks increase well beyond pipeline requirements, prices fall by default to what economists call market clearing levels. It’s little different than what retailers may do when grossly overstocked on inventory – they have a clearance sale. It’s just the same principle when you’re overstocked on a major ag commodity , and the clearance sale becomes global in scope. There are three critical elements of long-term commodity cycles: The length of commodity cycles is always measured from major low to major low, not from cycle high to cycle high. Why? See #2... The highs in any commodity cycle rarely occur at the midpoint between major lows. If they do, it’s called a symmetrical”cycle. But in the vast majority, cycle highs either come early (called “left translation”) or late (called “right translation”). The length of time between cycle highs is quite random, while the length of time between the lows doesn’t vary more than 10% either side of the predicted timing for the next cycle low. Knowing where the market is in a long-term cycle can help better determine whether or not to maintain a bias towards reluctant, cautious selling (such as shortly after a cycle low or very near a next “scheduled” cycle low), or aggressive selling somewhere in the middle third of the time between the last low and the next “scheduled” low. THERE ARE EIGHT DIFFERENT CHARACTERISTICS OF CYCLES. They were identified in a 1982 classic by Jake Bernstein: The Handbook of Commodity Cycles, a Window on Time: THE CYCLE PERIOD is the length of time from low to low, give or take a 10 percent margin of error. In other words, if the dominant cycle is 60 months from low to low, the next low may come as early as month 54 or as late as month 66. CYCLE RELIABILITY is measured by how often the cycle has repeated within its 10 percent margin of error over time. Some long-term cycles have repeated dozens of times if price history goes back far enough. CYCLE SYNCHRONICITY pertains to the tendency of some commodities to have cycles of similar length, but in alternation with each other. It’s most common among crops that have similar growing seasons and compete for the same acreage, such as corn and soybeans in the Midwest. CYCLE HARMONICS references the fact that some very long cycles can have sub-cycles of shorter length from low to low. Wheat, for example, has a dominant 9-year cycle often broken into two four-and-a-half-year cycles within each one. CYCLE INTERRELATIONSHIPS makes reference to tendencies for obviously-related commodities to either cycle together (such as soybeans, soybean meal and soybean oil), or to cycle just opposite each other, such as cycle lows in corn often coming a year or two ahead of long-term cycle lows in hogs (because cheap corn can lead to increased hog production). CYCLE MAGNITUDE references the price range from high to low rather than the length of time between the lows. For some commodities, such as corn, the magnitude is surprisingly uniform; the range from low to high is never less than 50 percent. And if it exceeds 50 percent, it typically doubles in price. If it more than doubles, it usually goes to two-and-a-half to three times the previous cycle low before peaking. INDEPENDENCE FROM FUNDAMENTALS is best explained as the reality that markets often make their highs when the fundamental news seemingly could not be more bullish, and their lows when the fundamental situation seemingly could not be more bearish. It’s a truth that has led to time-honored market axioms, such as “the time to get in is when everybody wants out, and the time to get out is when everybody wants in.” Another adage says that, “a market that fails to go up on new bullish news is a market topping out, while a market that fails to go down on new bearish news is a market that’s bottoming out." CYCLE PERSISTENCE is the tendency for dominant cycles to correct themselves if a major global event such as war or major drought in a key producing country throws them off outside the normal 10% margin of error. In such cases, the next cycle low will often come early or late to put timing for the next low back on track. The views expressed in this article are the author's alone and not those of Farmer's Business Network, Inc., its affiliates or members.
Apr. 18, 2018
First, be aware that there are purists among fundamental analysts who place all their faith in basic economic principles of supply and demand and often scoff, “All the ships that sank at sea had plenty of charts on board.” They see charts as little more than a scorecard showing whether market bulls or market bears have been winning recently, and see charts having little to offer about prices going forward. Pure chart technicians on the other hand, believe that at any given time, all that can be rea sonably known about current trends in supply and demand are already reflected in price by Adam Smith’s “invisible hand of the marketplace.” Further, they believe the charts themselves reveal which direction that invisible hand may be sweeping prices next. That faith is rooted in three basic assumptions: Markets very quickly and efficiently factor in (discount) fundamental events in supply and demand before those events become common knowledge. In such cases the news follows the markets rather than the other way around. Seeking fair value, price adjustments always take place over time in “trends” and that discerning that trend is a key to success, i.e. “the trend is your friend!” History tends to repeat itself in commodity price cycles dictated by the tendency of commodities to oscillate between surplus and shortage over time. For farmers, both fundamental and technical analysis play important roles. Solid fundamental analysis often provides the strongest basis for adopting a bullish or bearish outlook for prices going forward and one’s resulting pricing strategy. But technical analysis serves two very important purposes, one complementary to the fundamental view and the other competitive with it: Identifying the best timing for a move rooted in one’s fundamental outlook. Letting one know when the fundamental analysis may be just plain wrong. Bar Chart Basics: Identifying trend lines, support and resistance areas. Futures charts follow zig-zag patterns up, down or sideways. By definition, an “uptrend” is a zig-zag pattern of higher highs and higher lows. But in an uptrend, technicians often refer specifically to the “uptrend line,” warning that a close below this line would be a clear sell signal by breaking the uptrend. At the beginning of a new uptrend, you may have only two lows to connect with a straight line, but it won’t be confirmed or validated as the uptrend line until it’s tested a third time… and holds, sending prices higher again. By definition, a downtrend is a zig-zag pattern of lower highs and lower lows. But again, chart technicians frequently reference a specific downtrend line, noting that a closing price above that line would be a clear buy signal by breaking the downtrend. Notice a key difference: A downtrend line is always drawn connecting a series of highs. There can also be sideways trends, confined to well-defined trading ranges with nearly horizontal lines of overhead resistance and underlying support. Note that sideways trading ranges are often a sign of a bull market that’s topping or a bear market that’s bottoming. When confirmed by either a downside breakout from sideways range at the top of a chart or an upside breakout from a sideways range at the bottom of a chart, these sideways ranges are now termed a distribution top or distribution bottom by chart technicians. Also note that just as it takes at least three points of contact in a straight line to form an uptrend line or a downtrend line, it also takes at least three points of contact by near-parallel lines to confirm a sideways trend. Underlying “Support” and Overhead “Resistance” Areas: These are extremely common terms you often hear, even in text commentary without any graphics. Analysts will say something like, “The next support zone on weakness lies at $10.20, with overhead resistance at $10.80.” If they include a chart, those lines will be clearly drawn on the chart to help you see why. What causes overhead resistance to develop at certain price points: It’s rooted mostly in human psychology similar to the reasons uptrend lines and downtrend lines develop. The function of futures markets is price discovery. When an initial rally occurs, it typically halts for a breather at some point ,as buyers pause to see if any other buyers jump in to pick up the ball. If they don’t, then initial buyers begin to take profits and a break ensues. Here is an example of underlying support. It’s exactly the same human psychology reasoning as just described, but in reverse. For whatever reasons, a down-move comes to a halt at a certain price level. Buying interest exceeds selling interest and a rally ensues. But it’s short-lived and sellers regain the upper hand. But this time, selling again fades off at the same price point as before. Now more traders are thinking “the bottom might be in” and the next rally takes prices a bit higher yet before coming to a halt. Common formations identifying major tops or major bottoms. The 1-2-3 Top. This is one of the most common formations signaling the top of a significant bull market. Notice the first step was # 1, a break in prices that violated the uptrend line, what technicians call a “downside breakout.” The next step in the formation is # 2, a rebound that failed to take out the prior high, breaking the pattern of higher highs. Confirmation of the 1-2-3 top was # 3, another decline that took out the prior low at #1. The “Head-and-Shoulders” top is another formation signaling a top. This one has an added benefit from the 1-2-3 top: a way of gauging how much further down the move might go. Notice that once confirmed by the breaking right shoulder moving below the “neckline,” this formation portends the break will persist until it equals the distance from the neckline to the top of the head. And finally, there are reverse images of both these topping formations that signal bottoms. As with the head-and-shoulders top, the inverted head-and-shoulders bottom has the added benefit of predicting the initial upside target - a distance equal to the distance from the “head” to the “neckline.” That wraps up the primary assumptions behind technical analysis, as well as bar chart basics and what trend lines and common chart formations can tell us about market signals. The views expressed in this article are the author's alone and not those of Farmer's Business Network, Inc., its affiliates or members.
Apr. 11, 2018
Cynics often remark that the key to making a small fortune in futures trading is to start out with a large one, and it’s understandable. Sometimes it seems like a never-ending poker game between bulls always wanting to bet on higher prices and bears always betting on lower ones. But here’s a key truth: Whether you’re a farmer with a natural bullish bias or a buyer with a natural bearish bias, the key to winning each season’s high stakes poker game in the grain markets is to shed that bullish or bearish bias. These five considerations help guide us as we approach grain market analysis in an unbiased way. 1. “The Fundamentals” – These are the metrics of the U.S. and global supply/demand balance sheets updated for major crops monthly in the USDA World Agricultural Supply and Demand Estimates, known in the trade as the WASDE reports. The net effect of any changes in supply and demand prospects shows up as a change in ending stocks. And for hedgers and traders alike, the key to market impact is the resulting “stocks-to-use” ratio and how it compares to pre-report expectations for change. 2. “Dominant Market Psychology” – This is a reading of current bullish or bearish bias across a host of market analysts and advisors. When professionals are overwhelmingly bullish or bearish, something called “the law of contrary opinion” comes into play. That’s just a fancy term for the old market axiom that says, “the time to get into something is when everybody wants out and the time to get out is when everybody wants in.” Short of taking a costly poll of dozens of advisors and analysts each week, the best way to assess dominant market psychology is to make a judgement on who’s winning the constant tug-of-war between bulls and bears trying to make their case. A good ag economist can always make both the bullish and the bearish case if competently and faithfully monitoring market news and views. Next, it’s a matter of posting both lists (bullish and bearish) side by side. The list that’s growing longer and stronger reveals the dominant market psychology. 3. “The Technicals” – These are the current appearance and interpretation of trends evident on futures price charts. Are markets in an uptrend or a downtrend? Where’s the next overhead resistance (to further gains)? Where is the underlying support (that might stop a decline)? There are dozens of different approaches (tools) to technical chart analysis and multiple terms for different kinds of formations or even single-day events (like a “key reversal” or “breakaway gap”). Furthermore, nearly all the various technical studies have application to three different types of charts or each commodity: Daily charts plot the high, low and close for each trading day. They reveal short-term trends in place, over the past 3-6 weeks. Think of daily charts as the 5,000-foot view of the market. Weekly charts plot the high, low and Friday close for each week. They reveal intermediate-term trends in place, over the past 6-12 weeks. Think of weekly charts as the 20,000-foot view of the market. Monthly charts plot the high, low and end-of-month close for each month. They reveal long-term trends in place, over the past 6-12 months (or even longer) and offer the 50,000-foot view of the market. 4. “The Seasonals” – These are composites of average prices, month to month, over the past 5-10 years that reveal the tendency for the strongest prices or weakest prices to occur during different times of the year. You’ll read commentary such as “prices are weakening seasonally” or prices are “firming contra-seasonally.” 5. “Fund Activity” – Beginning in the mid-2000s, the amount of investment fund money flowing into commodity futures exploded. They are like mutual funds in stocks, drawing individual investors who want to diversify into commodities, but who entrust the trading decisions to professional fund managers. These commodity trading funds come in two varieties: trading funds and index funds. The trading funds will trade either side, long or short the market. Nearly all rely heavily on technical trading systems discussed earlier. Index funds are sometimes called the “long only” funds because they promote their value to investors as a hedge against inflation risk. They are always net long; all that changes is whether their collective position is adding to longs or selling some off. Fund activity is monitored weekly by the Commodity Futures Trading Commission and reported every Friday. Their activity factors heavily into a weekly assessment of “bullish consensus” by their sheer size. The views expressed in this article are the author's alone and not those of Farmer's Business Network, Inc., its affiliates, or members.
Apr. 04, 2018
Making sense out of crop marketing terms, like hedgers versus speculators, puts versus calls, derivative marketing tools and option premiums, can leave you scratching your head. But not understanding these terms can also complicate how you might make your next move in the markets. In this post, we'll break down some of the most common crop marketing terms and the ABC's of futures and options. A brief background on “hedgers” versus "speculators:" Hedgers take positions in futures to reduce existing risk, while speculators willingly take on new risk for the chance to profit from correctly anticipating changes in futures prices. Both hedgers and speculators are needed to generate sufficient trading volume and market liquidity on any given day for easy entry and exit of trades, whether long or short. Some of the most common terminology related to futures and options includes: Futures contract – a standardized agreement between a buyer and a seller to exchange an amount and grade of a commodity at a specific price and future date. Those who buy futures in anticipation of rising prices are said to be “long”. Those who sell futures in anticipation of lower prices are said to be “short.” Producers “hedge” their price risk on a growing crop by selling a futures contract at the current price. They’ve essentially eliminated downside price risk in futures, while remaining open to basis risk. If grain prices fall, profits in their hedged futures position will offset the declining value of their actual crop, while if prices rise, losses on their hedged position will be largely offset by rising prices for their actual crop. It may not be a perfect hedge, with penny-for-penny offsets, however. Changes in basis can still enhance or erode the net price change between futures and local cash bids. Others may eliminate price risk by buying a futures contract. Once they cover their needs with a long position in futures, if prices rise, profits in the futures position will help offset rising prices for inventory they’ve not yet purchased in the cash market; however, if prices decline, losses on their futures hedge will be offset by declining prices for inventory not yet purchased. Hedger – As noted earlier, a “hedger” is someone who reduces price risk by taking out a futures position just opposite his/her position in the underlying commodity. A soybean grower, for example, is automatically long in that he/she benefits if prices rise for a growing or stored crop and is harmed if prices decline. By selling a futures contract, a producer is “hedged” on that long position in the cash market. Going forward, if prices rise, the rising value of his growing or stored beans will cover losses on the futures while if prices decline, profits on his futures position will cover declining value of the beans in the field or bin. Speculator – Someone who willingly accepts or takes on price risk to profit from price change in their favor. In rawest terms, a speculator is anybody who goes long (buys) something solely to benefit from rising prices but suffers loss if prices decline instead. The term also applies to someone who goes short (sells) something he/she does not own and thus profits if prices decline and suffers loss if prices rise. In this sense, even farmers who never trade futures at all are speculators by growing or storing unpriced grain. A speculator can also be anybody who requires a certain commodity in their business and benefits from declining cost but is hurt by rising costs. For example, a cattle feeder is speculating on feed costs until he locks in the cost of feed required. Futures “carry” – the premium structure of deferred contracts over the nearby or “spot” contract. By definition, futures carry is related to the cost of storing grain so as to spread sales over a marketing year. But if you have grain in on-farm storage, it’s a different story. You have the interest cost and possibly some additional shrink adding up to perhaps 3 cents per month. A n ote on “carry:” In a true bull market, rallies are led by nearby contracts, often eliminating carry. It’s the market’s way of saying it wants corn now, not later. When nearby contracts are higher than deferred contracts, with no carry at all, the market is said to be “inverted” from its normal structure. Margin requirements – Since futures exchanges guarantee that no one will ever be denied rightful futures gains, they require both an initial margin requirement and maintenance margin thereafter when you buy or sell futures. That variation stems from variation in the “face value” of the contract. For example, a 5,000-bu. futures contract in corn at $3.80 has a face value of $19,000. A 5,000-bu. contract of wheat at $5.10 has a face value of $25,500 and a 5,000-bu. contract of soybeans at $10.25 has a face value of $51,250. Daily trading ranges often vary accordingly, thus the different margin requirements. Differing face value isn’t the only factor in different margin requirements among commodities. Exchanges calculate futures margin rates using a program called SPAN. This program measures many variables to arrive at a final number for initial and maintenance margin in each futures market. The exchanges adjust their margin requirements based on market conditions. The most critical variable is the volatility. In highly volatile markets, margin requirements will be raised. In dull, quiet markets, margin requirements may be lowered. In addition, margin requirements can be raised further by various brokerage firms based on their perception of 1) current risk in any given market or 2) risk-bearing ability on a client-by-client basis. This is often because the broker is held liable by the exchanges for losses their client cannot cover. They will set margin at whatever levels needed to minimize that exposure. Maintenance margins are typically set at half those initial margins. Keep in mind that both initial margin and maintenance margin varies significantly by commodity, reflecting variation in the face value of a contract, variation in daily trading limits, and the recent volatility of trade in that particular commodity . For example, in wild weather markets where soybeans might be trading regularly in 20-30 cent swings, margin requirements may be raised by the exchange. Futures options – Purchasers of options on underlying futures markets receive the right, but not the obligation, to accept a long or short futures position at a specific “strike price” sometime in the future for a fixed price called the “premium.” That premium is the most you may lose. There are no initial margins or risk of margin calls on purchased options, just the premium quoted plus the broker fee. If it never becomes profitable for you to exercise your option, it simply expires. But if it does become profitable for you to “exercise” your option at expiration, you are assigned the futures position at that strike price, even if the underlying futures price has yet to trade at that price. (A party who sold an option at that same strike price is simultaneously assigned the opposite position in futures, already at a loss and still exposed to further margin calls.) There are two types of options: Puts and Calls . A “put” option is the right, but not the obligation, to a short futures position at a specific strike price at a fixed premium. A “call” is the right, but not the obligation to a long futures position at a specific strike price in exchange for a fixed premium. Again, since there is no obligation to exercise an option that would entail a loss, you can just let it expire worthless, costing you only what you paid for it. Exercising is truly “optional,” hence the term. Options on futures may also be sold at the current premium for the offered strike price by those who expect it to expire worthless to the buyer. This is also called writing an option. Option sellers, however, are exposed to margin calls, just as if you had an outright position in futures. This is to insure if it becomes profitable for the buyer to exercise the option you sold, there’s enough margin (supplied by you) to cover his gain. Otherwise, the Exchanges would have to cover it. The premiums quoted for the various strike prices of puts and calls are typically determined by three primary drivers: “Intrinsic value.” This is the difference between the strike price and the current quote for the underlying futures price. “Time Value.” This is the amount of time between the present and expiration of the option. The longer that time, the higher the premium because there is higher risk to the seller that market conditions may change between, say, March and November than between March and May. In exchange for taking that greater risk, option sellers will need a higher time value component, over and above any intrinsic value. “Current Market Volatility.” This is a third element factored into the cost of options, whether puts or calls. The higher the recent volatility, the higher the risk associated with selling options and the higher the extra premium sellers will ask. Secondary drivers of option premiums worth mentioning are: 1) The current trend in the market 2) The current market psychology as to how much longer and further that trend will persist. There are also derivative marketing tools that derive their value from underlying futures contracts, but do not require you as the farmer to take a position in futures, or even have a trading account, for that matter. The counter-parties are the ones who have futures exposure. Here are some common ones: The Hedge-to-Arrive (HTA) contract . This allows you to lock in a futures price (effectively “hedge”) with his local merchant, but without exposure to initial margin requirements or margin calls. Minimum price contract . This guarantees you a minimum price for a fixed fee with opportunity to profit if prices rise. These typically involve the purchase of put options by the merchant at the minimum price locked in for the producer, often covered by the fee paid by the producer. And just like the HTA, another benefit to the merchant is guaranteed delivery and handling volume. Accumulator contract . This allows you to lock in sales of a specific total amount of grain at an initial price that’s often above current futures, spread over as much as the entire growing season. The initial price is paid for each weekly “batch” priced so long as the futures price falls between that minimum price and a “knock-out” price at which sales halt. The views expressed in this article are the author's alone and not those of Farmer's Business Network, Inc., its affiliates or members.
Mar. 29, 2018
If farmers want to move ahead of today's global grain trading environment, one of the first things to do is to better understand the history of where it all began. The Chicago Board of Trade (CBOT) was launched way back in 1848 by a group of 25 Chicago businessmen. It stemmed from shortcomings in the system at the time of strictly cash market activity between farmers and buyers, where a glut of grain offered at harvest inevitably meant rock bottom prices. At the time, grain buyers had no way of knowing what the price might be in the future, or if there would still even be any old crop grain offered for sale in the waning months of the year prior to the next harvest. There was already plenty of production risk in farming courtesy of Mother Nature. Balancing Crop Marketing Risk with Reward The founders of the CBOT reasoned that buyers and sellers ought to be able to commit for forward transactions at mutually agreed-upon prices, quantities, grades and delivery terms to reduce the additional element of price risk and uncertainty in their business. But a problem quickly developed when trading of such contracts was limited to bonafide producers and bonafide users. There was constant imbalance between the amount of grain being offered and the amount needed on any given day. Result: Unacceptable day-to-day volatility in prices for both buyers and sellers. That’s when CBOT founders decided to add trading volume and market liquidity, which allowed speculation by investors with no ability or intent to grow, or deliver to sell futures contracts, so long as they showed the financial wherewithal to accept the risk of prices rising. The Addition of Speculative Investors In a similar manner, investors with no ability or intent to accept delivery could buy futures, provided they showed the financial wherewithal to accept the risk of falling prices. It was controversial to be sure. Even back then there were fierce critics of speculation. Nonetheless, opening futures markets to speculative investors added the vital trade volume and liquidity needed to assure that whether buying or selling, hedgers could get in and out of positions easily on any given day. It had the added benefit of becoming a fair and valuable price discovery tool for both buyers and sellers. And, it helped to encourage production and ration usage in times of tight supply and to slow production and encourage more usage in times of surplus. There remain echoes of the early critics from cynics who still see speculation as a scourge and futures markets little more than casinos. Marketing Today's Crop But the echoes are growing more dim as the majority of today’s farmers see futures and options as the valuable risk management tools they were meant to be. The vast majority of today’s farmers understand full well that they are “long” on any portion of a growing or stored crop that is not priced or hedged (sold) in futures. They benefit from rising prices but are hurt by falling prices – exactly the same as an urban investor who is long “on paper.” In fact, in some cases, the farmer who is long a growing or stored crop faces more risk than the urban speculator because he or she is exposed to cash basis risk as well. Basis is the term given to the difference between a local cash bid, which varies widely across the country on any given day, to a specific futures contract which is the same for everybody on any given day. Variation in basis from locale to locale is a function of supply or demand imbalance at the local level, the time of year and variation in the cost of delivering grain to a recognized delivery point for satisfying a short position in futures. Want to tune up your grain marketing? Check out this free resource! The views expressed in this article are the author's alone and not those of Farmer's Business Network, Inc., its affiliates or members.