MARKETING ALTERNATIVES FOR GEORGIA FARMERS TRI-CO. YOUNG FARMER ORGANIZATION
INTRODUCTION • GOVERNMENT POLICY CHANGE • Strict regulations to market oriented system • Greater risk exposure (wild swings since 1972) • What to produce • How much to produce • When, Where, How to establish a price
INCREASED IMPORTANCE OF FOREIGN MARKETS • Changes in value of the dollar • Global weather • Political situations • Exports • Global economies
GEORGIA PRODUCERS MUST UTILIZE PRODUCTION AND MARKETING PRACTICES • Reduce risk • Increase probability of selling crops at a profitable price
PLANNING AHEAD • Production practices greatly improved • Marketing receives too little attention • Production and marketing go hand in hand in creating a successful farming operation • Effective marketing requires planning ahead • Where you want to go and how to get there
PRICE OBJECTIVE • Where you want to go – the sale of crops at a profitable price (Price Objective) • Be high enough to cover costs of production plus provide a reasonable return for risk and effort • Price objectives will be different for each farm
HOW SHOULD PRICE OBJECTIVES BE DETERMINED? • Don’t know the exact cost of production • Use previous farm history • Crop enterprise budgets
MARKETING STRATEGIES • No one strategy is best for everyone every year – Must evaluate farm situation • Ability to handle risk is key element • Risk – The chance or probability of a loss or an otherwise unfavorable outcome
TWO TYPES OF RISK • Production risk • Low yields, high production costs • Price risk • Unfavorable market prices
MARKETING ALTERNATIVES ALLOW FOR PRICING UP TO ONE YEAR PRIOR TO HARVEST AND MORE THAN ONE YEAR AFTER HARVEST • Marketing may include pricing portions of the crop over a period of time using more than one market alternative • Reduces risk but requires more attention to market situations
MARKETING STRATEGIES • Four things must occur for a legal transaction • Goods must be delivered from seller to buyer • Price must be agreed upon • Transfer of legal title must occur • Payment must be made from buyer to seller • All create possibility of marketing alternatives
FORWARD PRICING ALTERNATIVES • Price of the commodity is established prior to delivery to the cash market buyer • Available for a year or more prior to the actual harvest and may be used after harvest
DELIVERY PRICING ALTERNATIVE • Price determined at the time of delivery to buyer • Take place at harvest or out of storage
DELAYED PRICING ALTERNATIVE • Pricing determined at sometime after delivery to the buyer
FLOOR PRICING ALTERNATIVES • Minimum price is established for the commodity but allows for receipt of upside price movements • Commodity options • Government loans
FORWARD PRICING ALTERNATIVES • Hedging in the Futures Market • Very complex and sophisticated marketing alternative • Better know what you are doing • Knowledge of futures market is needed to understand how prices are established for farmers
FUTURES MARKETS • The markets are where prices are established for the future delivery of commodities • Prices determined by traders making public bids and offers on the trading floor • Contracts to deliver or receive a specified quantity and quality of a commodity at a specified price, place, and time in the future
CONTRACT OBLIGATIONS • Can meet the obligation of a contract by making an opposite or offsetting transaction in the same delivery month. • Sell one November soybean contract – Get out of the contract by buying one November contract before the maturity date (near the twentieth of the month) • Use futures markets to shift price risk to someone else – not an actual sale and delivery of the crop (before the maturity date)
PRICE RELATIONSHIPS • Local and futures prices generally move in the same direction but will not usually be the same amount • Georgia prices tend to be higher than Iowa prices
BASIS • The difference between local cash price and the futures market price • Reasonably predictable • When to use futures market – Trade risk of predicting cash price for the lesser risk of predicting the basis
TWO DISTINCT GROUPS OF FUTURES MARKET PARTICIPANTS • Hedgers • Use futures markets to establish a price of a commodity which will be delivered in the future • Very few farmers hedge but most grain elevators, feed mills, etc. hedge
Speculators • Do not wish to receive or deliver the actual cash commodity • Buy and sell futures solely to profit from price changes • Are important to make the futures market work • Assumes price risk and allows for easy entrance and exit from the market
THE HEDGING PROCESS • Determine price objective • Large enough to cover your estimated costs of production including profit and storage costs if appropriate • Localize the quoted futures price • Select appropriate futures contract month • Find most recent price quote for futures contract month • Adjust for local market “basis”
HEDGING PROCESS CONTINUED • Deduct the costs of using the futures market • Broker commission fee (1 cent per bushel) • Interest on margin account • Good faith money (5 – 10% of value of contract – Returned when end contracts • Annual interest fee (12% for 6 mos.) • Total of about .05 per bushel
HEDGING PROCESS CON’T • Make a decision • Execute the hedge • Hire a broker • Deliver an order to sell contract at or above target price • When harvesting crop, sell at local cash market, and deliver an order to buy a contract
TWO TYPES OF HEDGES • Production hedge – Forward price growing crop or crop yet to be planted • Storage hedge – price on stored crops which locks in return to storage
HEDGE EXAMPLE # 1 HANDOUT WHEN PRICES DECREASE AT HARVEST
HEDGE EXAMPLE # 2 HANDOUT WHEN PRICES INCREASE AT HARVEST
CASH FORWARD CONTRACTS • AGREEMENT BETWEEN A SELLER AND A BUYER FOR A SPECIFIED QUANTITY AND QUALITY OF A CROP AT A SPECIFIED PRICE AND DELIVERY PERIOD • MAIN FACTOR USED BY BUYER IN SETTING A CASH CONTRACT BID PRICE IS THE CURRENT FUTURES PRICE FOR THE MONTH NEAREST THE DELIVERY DATE (NOT BEFORE)
FORWARD CONTRACTS CON’T • Buyer usually hedges the purchase in the futures market or immediately sells to another buyer • Advantages • Shift price risk to buyer • Disadvantage • If fail to produce may have to buy to meet commitment
DELIVERY PRICING • Cash sale at harvest • Cash sale out of storage • Disadvantage • Lost opportunity cost • May have to take what you can get for a price at the time
DELAYED PRICING • Price Later Contracts • Commodity is delivered, title changes hands, the seller may accept the price offered by the buyer or any given day within some time period • Buyer usually hedges purchase to secure price
DELAYED PRICING CON’T • Basis Contracts • Commodity is delivered • Title changes hands • Seller selects a futures market contract month near the date of expected sales upon which the price will be based • Buyer assigns a basis to the futures contract • Seller agrees to price the contract before the futures contract matures
Basis Contract Con’t • Advantage • Buyer often makes a partial payment • Disadvantage • Seller gives up any opportunity for basis appreciation
FLOOR PRICING ALTERNATIVES • Establish a minimum price for a crop while retaining the ability to capture upside price movements • Two Methods • Government Loan Program • Commodity Options
GOVERNMENT LOAN PROGRAM • Non-recourse loans by USDA through Commodity Credit Corporation (CCC) • Stored crop is collateral • Generally 9 months in duration • Loans sometimes extend 3-5 years through Farmer Owned Reserve • Sec. Of Agriculture sets loan rates – provides a floor price
GOVERNMENT LOAN CON’T • Grower has the option of selling the crop and repaying the loan plus interest or forfeiting the crop to the CCC in lieu of loan repayment • At a minimum the grower should receive the loan rate less storage costs
COMMODITY OPTIONS Provides an opportunity, but not an obligation, to sell or buy a commodity at a certain price
COMMODITY OPTIONS CON’T • Purchaser pays a premium (like insurance) to put a floor on selling price or a cap on a buying price of a commodity
There are two kinds of options • PUTS • Gives you the right, but not the obligation to go short, or sell, a futures contract upon expiration. • Puts gain value as prices fall and are primarily used for planting strategies by hedgers • Most hedgers close out their contracts and do not convert them to actual futures contracts • If you bought a put in the spring and it gained value because prices fell, you would sell a put at the same strike price to exit your position. Profit would be the difference to be added to the cash price you received
SECOND KIND OF OPTION • CALLS • Gives you the right, but not the obligation to go long, or buy, a futures contract upon expiration. • Calls gain value as the market rises and are primarily used for harvest strategies by hedgers • Allow for profit from upward price movement after the sale of the commodity • If your call option gained in value you would offset your position by selling a call at the same strike price. If prices went down, let option expire
COMMODITY OPTIONS
STRIKE PRICE • The price at which you want your level of coverage • Out of the money – not earning money yet and the premium is less expensive • At the money – at the current selling price and will earn money when the market moves. The premium is average • In the money – option is already earning money and the premium is most expensive
DETERMINING WHAT STRIKE PRICE TO CHOOSE • Know your cost of production • Determine how much risk you can afford to take • Determine how much premium you can afford to pay
Strike Price – Premium = Price Floor Option Cost X Contract Size = Premium
