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Wednesday, July 25, 2012

Hedge Your Revenue Protection Policy To Avoid Losing High Prices Before Harvest


The short crop of 2012 is currently being rationed by the market and once a peak price is reached, it will be downhill for a long time.  Thus the marketing adage, “short crops have long tails.”  The challenge for commodity producers is to understand the market and take advantage of what it offers, in addition to the marketing of cash grain.  One of the opportunities may be close at hand, if not already within grasping range.
Generic data from USDA’s Risk Management Agency indicates about 75% of producers have crop insurance, and many of those have some of the new Revenue Protection policies that offer both price and yield guarantees.  If you have an RP policy, it currently provides a price guarantee for a harvest price that may be at, near, or just past its peak.  And if so, it may be time, as Grandpa said, to “strike while the iron is hot.”
University of Illinois Farm Management Specialist Gary Schnitkey writes in a recent <a href=" " title="newsletter "><b>newsletter </b></a>about concerns the harvest prices guaranteed by the RP policies will peak before the Month of October, when the harvest price is set for both corn and soybeans.  While that is a mechanical part of the crop insurance policy, Schnitkey says there are ways that current prices, which may be higher than what will occur in October, can be captured.  For example, if prices fade by $2 between now and October, acting now will allow you to pocket that $2 instead of “leaving it on the table.”
RP policies will use your trend-adjusted Actual Production History yield, multiplied by the harvest price, if that is higher than the $5.68 spring guarantee, which it currently is by just over $2 on July 25.  Schnitkey says harvest prices most likely will be above the $5.68 projected price, but those prices have faded over 20 cents since the $8 peak last week.  And he adds, “As long as the futures price remains above the projected price, reductions in futures prices from current levels will result in lower insurance payments and vice versa. The possibility of lower prices leads to incentives to hedge up to the yield guarantee.”
Using an example of a 175 bushel trend-adjusted yield with 80% coverage, a producer would have a 140 bushel guarantee, priced at the value of the December corn futures contract during October.  By selling a December futures contract now at the current $7.80 price, then buying it back in October with the insurance guarantee to offset the position, the producer has taken advantage of today’s higher prices.  If the October price is $6.80, the producer has made an extra $1 with the hedge.  If the October price is 8.80, the producer has lost $1 on the hedge, but has made up the loss with a higher price for his cash corn.  Subsequently the current $7.80 price is part of the producers’ marketing plan.   Schnitkey says, “Hedging the entire APH now will lock in the sum of crop revenue and the insurance guarantee. Note that the actual yield does not have much impact on total revenue. Lower yields than those illustrated above will result in lower crop revenue and higher RP payments and vice versa. Slight differences in revenue as yields are lowered; exist because of the basis between the cash and futures prices.”
Schnitkey says there are some risks to the strategy, which include potential hedging losses, margin calls, and the $11.36 limit on the RP harvest price.    Also, he says smaller portions could be hedged, instead of the entire 140 bushel guarantee.  Additionally, the action could be broken into a number of smaller pieces with the hedging over a number of weeks to gain an average of that period.  
Producers may want to hedge all or a portion of their yield guarantees to take advantage of high prices that currently exist for harvest-time futures contracts. While prices could move higher, current prices would allow many farms to lock in profits, a situation that may exist later in the year.

Posted by Stu Ellis on 07/25 at 10:27 PM | Permalink

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