OPPORTUNITIES AND RISKS
many growers have understandably been frustrated at not being able to capture the price spikes seen in grain futures over the past few years. Local buyers are often unable to pass on the elevated prices in Chicago and Minneapolis as demand from end users does not flow through to local markets. Buyers also find it difficult to maintain enough equity to support their hedges. As a result basis levels fall and buyers are forced to periodically withdraw from the market.
The only way for growers to fully participate in the futures market is to do it themselves. In the past 10 years technology has made futures trading much more accessible and affordable for producers. In the time it takes to open a bank account, growers can set up an online or telephone trading account.
The most basic futures trading strategy would involve growers selling futures contracts (short selling) when they normally would contact their local grain buyer to lock in a price through a forward contract. When growers sell their physical crop, they would simultaneously buy back their futures contracts. During this time any price movement on the physical market should be matched by profits or losses on the futures market. For example, if the physical price drops from $5 to $4 during this time the grower will sell their grain at harvest for $4 but also make $1 profit on the futures trade (sell for $5 and buy back for $4).
More sophisticated strategies would involve hedging against currency changes, the use of options to secure a floor price while maintaining the ability to capitalize on gains, and the use of target prices and stop-losses to automatically buy or sell contracts.
risks and limitations
Futures trading holds some inherent risks and limitations and therefore is not for everyone. With this type of trading, farmers are subject to standard contract sizes. Whereas local buyers can offer growers contracts of virtually any size, futures contracts are for a standard 5,000 bushels (corn, wheat or soybeans). This may not suit small growers.
Maintaining margins can also be a challenge for a farmer when trading futures. Brokerage accounts provide users with an equity margin which must be maintained. If the price moves against the user’s position the broker will call on the user to deposit funds (a margin call). If funds are not deposited on time (usually one to two days) the broker will close out the user’s contracts to retrieve equity. With the amount of volatility in the futures markets, maintaining equity can be a major challenge for growers.
Another risk to this type of trading is changes in the basis. Unlike forward contracts, trading futures will not protect growers against changes in basis levels. Basis levels have become much more volatile in recent years in response to the increased volatility on the futures markets.
what to look for in a broker
- Low spreads (the difference between the buy and sell price)
- Suitable fee structure (watch for hidden fees for margin calls, payment processing, requirements to undertake a minimum number of trades per year, etc.)
- Access to a good trading platform and market intelligence
- Leverage margins which your business can maintain
- Practices regulated by government
- Customer service – discount brokers will not offer the same level of service most farmers are used to receiving from a grain company
By using forward contracts growers are essentially outsourcing the task of hedging futures to grain buyers and avoiding the associated risks. The cost to the grower is the inability to capitalize on every opportunity in the futures market. Growers who have the time, expertise, capital and appetite for risk may benefit from taking back control and managing their own futures trading account. •