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What to Keep in Mind Before Starting a Marketing Plan

February 16, 2012 by John Payne| Tips & Strategies

As commodities prices rally, producers of goods should be taking a hard look at marketing plans that will hedge downside price risk. When the U.S. initiated credit swap lines with Europe back in mid-December, commodities rallied across the board. Producers have had the bull in their corner; but with uncertainty in these markets being far from over, marketers should be looking into ways to lock in prices at these levels by using hedging strategies on the board. For producers who are new to hedging, there are a few things they should keep in mind before beginning.

In the agriculture world, hedging can be a dirty word. Everyone knows somebody who was involved with futures or options and lost money. When I hear stories about losing money, I always wonder what went wrong. Was it a misunderstanding between the producer and the advisor? Was there not enough cash to hold the hedges? Did the producer not coordinate his position adjustments on both the cash side and futures/options side? Most of the time, it’s a combination of those reasons combined with a lack of expectation setting that should be provided by the advisor.

Please click to view the Options risk disclosure below.

Here are a few points to keep in mind before embarking on any marketing plan:

  • Farmers or producers are inherently LONG the grain they choose to farm or produce. If a producer is planning to farm 50,000 bushels of corn, then they are the equivalent of being long 10 contracts of corn (1 contract = 5000 bushels). The feeling a farmer has being exposed to 10 contracts of price risk probably doesn’t feel the same as the speculator who bought or sold 10 contracts on his own, but the risks are equal. A big difference is the farmer doesn’t receive a daily statement from his bank telling him what his crop is worth every day. They aren’t bludgeoned with account statements or calls from FCM’s looking for them to meet a margin call.
  • Most successful marketers don’t price their entire production at one time. They hedge incrementally throughout the year, rewarding the rallies that will inevitably come. Doing so helps eliminate seller’s remorse.
  • The futures account and the account where the producer banks cash sales should be thought of as one in the same. They move together like a see-saw. The funds in the cash account may have to go to the brokerage account to support the futures/options positions, but that means that the farmer will be selling their product at higher prices. If they can’t meet a margin call or get credit to meet that margin call, then they should avoid marginable positions.
  • If you lift a hedge in your futures account, make the corresponding cash sale on the physical side to offset the removal of hedges. The biggest mistake I see is when a farmer will exit a hedge and hold on to the product. This is a recipe for disaster. If a farmer is in a hedge, the futures account may take a loss, but that should be offset by the gains on the cash side. By lifting a hedge and not selling the product, the hedger could lose on the futures side and the cash side. This is the most common mistake we come across when analyzing a producer’s past experiences.
  • The more a hedger pays up front for the hedge, the less they will have to worry about margin calls should the market move against their positions. Those who only buy puts never have to worry about a margin call. Those who do collars and sell options will need to keep an eye on the margin and liquidity levels in their accounts. It’s important to be able to keep the account liquid so the hedges can be kept in place, if the hedger decides to exit the hedges because their short calls would be under pressure, they need to sell their production.
  • Consult your banker before starting. A hedging plan should be something they recommend as well. Commercial bankers get uncomfortable when their customers sell production at prices under cost. They will encourage any producer to do whatever it takes to avoid that.
  • Never get over sold. Don’t sell production you don’t have – or won’t have. Most of the horror stories we hear from producers who have experienced bad hedging make this mistake.

There are several points to consider before hedging. Speak to a good advisor who can explain in layman’s terms how hedges work and what will happen to both the cash account and futures account if prices go a certain direction. There’s no better place to start than giving a Daniels Trading advisor a call at +1.800.800.3840. We promise to listen first and talk straight.

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Filed Under: Tips & Strategies

About John Payne

John Payne is a Senior Futures & Options Broker and Market Strategist with Daniels Trading. He is the publisher of the grain focused newsletter called This Week in Grain, along with being a co-editor of Andy Daniels’s newsletter, Grain Analyst. He has been working as a series 3 registered broker since 2008.

John graduated from the University of Iowa with a degree in economics. After school, John embarked on a 4 year career with the United States Navy. It was during two tours in Iraq and the Persian Gulf where John realized how important commodities are to the survival of society as we know it. It was this understanding that brought about John’s curiosity in commodities. Upon his honorable discharge in 2007, John’s intense interest in the world of commodities inspired him to move to Chicago and pursue his passion in a career in the futures arena.

After a three year position with a managed futures firm specialized in livestock trading, he was given the opportunity to join the team at Daniels Trading. Being in the business and seeing how other IB’s operated, it was the integrity and straightforward approach of the Daniels management team and brokers that attracted him to make the move. Since joining Daniels, John has broadened his fundamental and technical analysis of the markets even further. John has been writing his newsletter This Week in Grain under the Daniels banner since 2011.

Working in high pressure industries like the military and capital markets, John has learned the value of preparation in times of stress. He believes that instilling within his clients the value of a good plan and a cool head for dealing with the day to day swings of commodity markets. He treats every client as a teammate, understanding that his job is to help clients achieve their goals, whatever they may be.

John is a proud supporter of the Iraq and Afghanistan Veterans of America, the Veterans of Foreign Wars and the National Corn Growers Association. When he is not working, he enjoys athletics of all kinds and spending time with his wife and their two kids.

John’s commentary is featured in the following publications:

* All Ag Radio – Sirius Channel 80
* AM 880 KRVN – Lexington, Nebraska
* RFD TV
* Wall Street Journal
* Barron’s
* China News Daily (English version)

Risk Disclosure

WHEN INVESTING IN THE PURCHASING OF OPTIONS, YOU MAY LOSE ALL OF THE MONEY YOU INVESTED.

WHEN SELLING OPTIONS, YOU MAY LOSE MORE THAN THE FUNDS YOU INVESTED.

This material is conveyed as a solicitation for entering into a derivatives transaction.

This material has been prepared by a Daniels Trading broker who provides research market commentary and trade recommendations as part of his or her solicitation for accounts and solicitation for trades; however, Daniels Trading does not maintain a research department as defined in CFTC Rule 1.71. Daniels Trading, its principals, brokers and employees may trade in derivatives for their own accounts or for the accounts of others. Due to various factors (such as risk tolerance, margin requirements, trading objectives, short term vs. long term strategies, technical vs. fundamental market analysis, and other factors) such trading may result in the initiation or liquidation of positions that are different from or contrary to the opinions and recommendations contained therein.

Past performance is not necessarily indicative of future performance. The risk of loss in trading futures contracts or commodity options can be substantial, and therefore investors should understand the risks involved in taking leveraged positions and must assume responsibility for the risks associated with such investments and for their results.

Trade recommendations and profit/loss calculations may not include commissions and fees. Please consult your broker for details based on your trading arrangement and commission setup.

You should carefully consider whether such trading is suitable for you in light of your circumstances and financial resources. You should read the "risk disclosure" webpage accessed at www.DanielsTrading.com at the bottom of the homepage. Daniels Trading is not affiliated with nor does it endorse any third-party trading system, newsletter or other similar service. Daniels Trading does not guarantee or verify any performance claims made by such systems or service.

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Risk Disclosure

This material is conveyed as a solicitation for entering into a derivatives transaction.

This material has been prepared by a Daniels Trading broker who provides research market commentary and trade recommendations as part of his or her solicitation for accounts and solicitation for trades; however, Daniels Trading does not maintain a research department as defined in CFTC Rule 1.71. Daniels Trading, its principals, brokers and employees may trade in derivatives for their own accounts or for the accounts of others. Due to various factors (such as risk tolerance, margin requirements, trading objectives, short term vs. long term strategies, technical vs. fundamental market analysis, and other factors) such trading may result in the initiation or liquidation of positions that are different from or contrary to the opinions and recommendations contained therein.

Past performance is not necessarily indicative of future performance. The risk of loss in trading futures contracts or commodity options can be substantial, and therefore investors should understand the risks involved in taking leveraged positions and must assume responsibility for the risks associated with such investments and for their results.

Trade recommendations and profit/loss calculations may not include commissions and fees. Please consult your broker for details based on your trading arrangement and commission setup.

You should carefully consider whether such trading is suitable for you in light of your circumstances and financial resources. You should read the "risk disclosure" webpage accessed at www.DanielsTrading.com at the bottom of the homepage. Daniels Trading is not affiliated with nor does it endorse any third-party trading system, newsletter or other similar service. Daniels Trading does not guarantee or verify any performance claims made by such systems or service.

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