If I weren’t a grain market analyst, I would want to have the job of the person who compiles all the strange statistics for football announcers to tell the crowd in between plays:
“This is Jackmerius Buckshank’s seventh interception in the past eight games played west of Mississippi River on Sunday nights, John.”
“That’s right, Al, and all with the help of his teammate Buster Goodling-Splatt, whose rookie season is following up an incredible career at Southeastern State, where he had an average of 0.85 sacks per quarter.”
But here’s how it would go for the grain markets recently:
John: “The soybean market has posted an astonishing 8.2% return in the past six trading sessions.”
Al: “But that’s something it has done 97 times in the past two decades.”
John: “Rare for such progress to go unanswered by the corn market, though. Corn has only gained 1.9% to counter soybeans’ big rally.”
Al: “Right you are. In fact, only 19 of those past 97 bigger-than-7% soybean rallies were done without corn following along with a gain of 2% or better. It happened once in July 1996, then a bunch of times through the following decade, but now we haven’t seen this happen since August 2009.”
John: “That’s right, Al. Very unusual. Still, the team that wants to win this game is going to have to score more points than the other team.”
The grain markets aren’t a win-or-lose game. Both markets can be winners or losers simultaneously. Nevertheless, the price movements of the past week are showing different outlooks for the two row-crop markets. They require different strategies for deciding to hold or to sell remaining 2016 bushels.
Let’s not complicate the decision with on-farm storage opportunities of various costs or idiosyncratic basis opportunities. Let’s only consider grain that was brought into an elevator at harvest, then put away on “storage,” or more likely, put on a “price later” or “deferred pricing” contract. In the middle of January, with cash corn bids averaging about $3.30 across the country, and cash soybean bids averaging about $9.95 — should you sell those tucked-away bushels now? Or should you wait?
I’ve looked at a number of those “price later” programs across the U.S., and they typically involve paying either 5 cents per bushel per month, or 10 cents per bushel upfront and then 3 cents per bushel per month, prorated, from harvest delivery onward. At either of those price schemes, we’re talking about 20 cents or more per bushel already tied up by the middle of January. Twenty cents is 6% of corn’s cash value right now, but at this point, it’s a sunk cost, so let’s not worry about that too much. The question is: Should you stay in for another month, at 5 cents, to see if prices go higher in the next few weeks?
Look at it like a call option contract — a “price later” policy gives you the opportunity to maybe take advantage of better prices in the future. But unlike a call option contract, it doesn’t close you off from any downside risk. If prices move even lower from here, you’ll just lose your 5 cents per month PLUS whatever the market loses. So, in a rational world, “price later” policies should definitely cost a lot less than a call option.
Unfortunately, they don’t. You could own upside exposure to the corn market between now and June 23 either by buying an at-the-money July corn call for 20 cents today, or you could own that upside exposure (and simultaneous downside exposure!) by keeping your corn in a “price later” policy through the middle of June for an extra 25 cents, if the elevator is charging you 5 cents per month. That’s why farmers with “price later” corn typically don’t keep it in the program for that length of time, even if that’s how long it might take to see a seasonal corn rally.
But how about just for the next few weeks, or just a couple more months? Unsurprisingly, volatility measures in the soybean market have jumped up quite a bit during the past week of double-digit trading sessions, but in the quieter corn market, the implied volatility in the options market is unusually low. At this time of year in each of the past five years, implied volatility for at-the-money July calls has been over 20%, and usually more like 23%. In the middle of January 2017, the implied volatility for July corn calls is only 19%. The current volatility measure (21-day volatility, annualized) on the front-month corn chart is only 16.4%.
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What this means, in Normal Probability terms, is that the market thinks there is a 68% chance that corn prices won’t move up or down more than 18 cents in the next month. Or, to extend this out by a couple more standard deviations, if you keep the grain in the “price later” contract for another month, you’re effectively paying 5 cents for a shot at $4.00 (the market is 95% confident it won’t go higher than that), but you have an equal chance at seeing the front-month futures chart at $3.29, which would make the average cash price only $2.94.
But hold on. Don’t feel too bad about the scenario. There was a reason we ended up here. Everybody hated the idea of selling sub-$3 corn at harvest, and at the time, maybe paying 5 cents a month didn’t sound awesome, but at least it sounded like a chance. Like an onside kick when you’re down by 10 points with 4 minutes left in the game … at least it’s a chance.
Also, it’s not like 5 cents a month (or 3 cents a month or whatever your local elevator’s charge may be) is unreasonable. It costs real money to store grain and keep it conditioned from one month to the next — money for buildings, for electricity, for overhead, for insurance and financing, etc. The full cost of commercial carry for corn between March and May 2017 is estimated at 5.9 cents per month.
But the “price later” strategy will always make more sense for some crops than for others (5 cents per month eats up relatively less of the take-home price tag on a bushel of soybeans than it does on a bushel of wheat, for instance), and it makes more sense in some years than others. In some years, the markets will be quite volatile and the chances for wild upward swings will be greater. The greater the volatility of the underlying asset, the more valuable any option contract, or any option-like strategy, will be.
Most importantly, this is a good reminder to avoid this scenario in the future. If we have a hunch that we’re going to like spring prices better than fall prices — and we typically do indeed enjoy spring prices more than fall prices in any normal year with abundant production — then we don’t have to pay storage fees or “price later” fees to get spring prices. We just need to lock those prices in during the PREVIOUS spring. Pre-harvest hedging is probably the most valuable page in any grain marketer’s playbook, and it’s not too early to be looking at opportunities for 2017. After all, it can be done for free! And as John Madden would say, the marketer who doesn’t waste money on storage fees and “price later” charges will make more money than one who does.
Elaine Kub is the author of “Mastering the Grain Markets: How Profits Are Really Made” and can be reached at email@example.com or on Twitter @elainekub.