Guidelines for Hedging Your Crops

Written by Katie Tangen, Marketing Education Specialist

You shouldn’t hedge more than 25% of your production the first time you hedge until you are familiar with the mechanics of hedging. In fact, hedging 5,000 bushels (one contract) is preferable for the first trade. You shouldn’t sell more than the prevented plant maximum of any crop, including multiple years, until you can see it in the field. Avoid more than 25% of your crop at any one time unless you are anxious to pass risk away fast and achieve some specific management objective. Spread your sales out. Try to avoid selling more than half of your crop during one quarter of the year, unless you have a very strong reason and market objective for doing so. Never hedge 100% of a growing crop regardless of how sure you are that you will get it to harvest. Producers should stay underneath their crop insurance guaranteed bushels until they have harvested.

Over the past six to nine months, commodity markets have seen volatility the likes of which we have not seen for some time. While this is offering producers opportunities with pricing they haven’t seen in several years, it also creates some pressures and strains that can be difficult to deal with. This is especially true for producers utilizing hedging accounts to remove a portion of their revenue risk.

With that in mind, here are some reminders and guidelines to manage those hedge accounts:

Keep in mind, these are generalizations. Each operation is different and the points above are where discussions should begin on your farm and with your lender.

Another question we get asked lately is, “How much money should I have available to hedge?” During initial establishment of a hedge line, we would recommend planning for a $2-$3 move in corn and wheat, $2-$4 move for soybeans, and $10-$15 move in cattle and hogs.

For illustration purposes, we will assume a farm with 1,000 acres of corn & soybeans in a 50/50 rotation would like to set up a hedge line to market 25% of their projected corn production. Actual Production History (APH) of the operation is 200 bpa and they carry 85% coverage.

STEP ONE Initial set-up of the hedge loan

In order to provide the recommended liquidity needed to support the hedging needs, first determine how many contracts worth of production you are looking to hedge. Remember – one contract equals 5,000 bushels of corn. So,

on 1,000 acres in a 50/50 rotation, hedging 25% of the anticipated corn production at 200 bpa would require five contracts:

For each contract, you need liquidity for the initial margin. Let’s assume initial margin at the time you evaluate is $1,500 per contract. You also need to allocate for moves in the market. Since markets had not been very volatile at the time, you likely chose to go on the low side at $2 per bushel.

So, our overall needs for the hedging line amount to:

Please remember margin amounts are for example purposes only. Speak with your broker to determine exact margin requirements as they are subject to change.

1,000 A 50% rotation 200 bpa 25% of production 25,000 bushels/5,000 contracts= 5 contracts

+

(5 contracts x $15,000 margin per contract) (25,000 bushels x $2 per bushel) $7,500+$50,000=$57,500

STEP TWO Market runs with increased volatility

At this point, the market has made a significant run since you first hedged the allocated bushels and is closing in on the $2 per bushel estimate initially used. The CME has also provided notice it will be increasing margin requirements on corn contracts by $500 per contract due to the increased volatility. How much more needs to be added to the line to ensure adequate liquidity? This will need to be broken down into two steps. First – how much more do we need to add to maintain margin requirements? Second, how much more do we need to stay with the positions if the market continues to rise?

The additional margin will be $2,500 minus $500 additional per contract ($2,000 - $1,500) times the five contracts we figured earlier.

Based on current market forecasts at the time of evaluation, there could be up to another $1 of potential upside in the market. If that occurs, it would require another $25,000 of available liquidity minus $1/bu x 25,000 bu.

To provide for the current margin requirement increase and potential future market moves, add an additional $27,500 ($500 per contract + $25,000 in additional room) to the hedging line, bringing it to $85,000.

Using $85,000 for 25,000 bushels of production equals $3.40/ bu of liquidity we are providing to hold these positions, or $170 per acre of corn planted. Remember, this example takes into account marketing only 25% of the anticipated corn production. If the remaining 75% is unpriced, it is also increasing in value.

This may sound like a lot, but remember, if you are hedging when you make the cash sale, everything will offset. That brings us to our last, and possibly most important point: Once the cash sale is made, the hedge must be lifted. Continuing to hold the position after that point is speculation and puts you at risk of incurring substantial loss. Hedging in these conditions is probably one of the most psychologically challenging management duties. It requires significant discipline and control, but it is ultimately rewarding as you continue the practice of pricing ahead.

For additional info, contact Katie Tangen or Rob Fronning: katie.tangen@agcountry.com robert.fronning@agcountry.com

IMPORTANT CROP INSURANCE DATES!

(Spring Crops Only)

JUL 15 Acreage Reporting

AUG 15

Premium Billing

SEP 30

Premium Due to Avoid Interest Charges

Please submit your acres as soon as possible so we can process them. This will allow you enough time to verify the acres on the schedule of insurance by July 15th .