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January 2004

ER04-01

The Farmer's Grain Marketing Guide

Carl L. German

Extension Specialist, Marketing 208 Townsend Hall

University of Delaware Newark, Delaware 19717-1303

clgerman@udel.edu phone: 302-831-1317

-In collaboration withLinda Smith, Managing Editor, Top Producer, Farm Journal, Inc.

& Dr. Art Barnaby, Professor, Department of Agricultural Economics

Kansas State University

Cooperative Extension Education in Agriculture and Home Economics, University of Delaware, Delaware State University and the United States Department of Agriculture cooperating. Distributed in furtherance of Acts of Congress of May 8 and June 30, 1914. Delaware Cooperative Extension, University of Delaware. It is the policy of the Delaware Cooperative Extension System that no person shall be subjected to discrimination on the grounds of race, color, sex, disability, age or national origin.

i

Acknowledgements Funding for this project was provided by the Northeast Center for Risk Management Education, The Delaware Department of Agriculture, and Con Agra. The authors would also like to express their appreciation to the many contributors to this project. Specifically, Charlie Stubbs, Grain Merchandiser, Perdue Farms, Inc. deserves special recognition for his insights into the intricacies of the many marketing alternatives that are available to the grain farmer. His insights were very valuable to the Units written on Cash Marketing Alternatives and Basis.

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Prelude This publication is available as an interactive online e-learning course at . To learn more about the online course click on AgWeb Professional, scroll through the list of Market News advisory services to the bottom of the list to `The Farmers Grain Marketing Guide', listed under the heading On Line Learning. The course covers Market Planning, Cash, Basis, Hedging, Options, Crop Insurance, and Selected Resources. The interactive course is available on a fee basis from . This publication contains a descriptive version of the online course. Content questions regarding Units 1-5 and Unit 7 should be directed to Carl L. German, Extension Marketing Specialist, University of Delaware, Phone: (302) 831-1317 or email clgerman@udel.edu. Content questions regarding Unit 6 should be directed to Art Barnaby, Professor, Agricultural Economics, Kansas State University, Phone: (785) 532-1515 or email abarnaby@ksu.edu.

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Table of Contents

Extension Clause

i.

Acknowledgments

ii.

Prelude

iii.

Introduction

1

Unit 1. Market Planning

Introduction

1

Eight Basic Steps to Grain Market Planning

1

Establish Price Objective Based Upon Cost of Production

Keep Abreast of Market Developments

Learn to Use and Understand Historical and Current Basis Information

Select the Appropriate Sales Method

Become Familiar With Contract Information and the Language of the Marketplace

Plan Sales According to Cash Flow and Income Needs

Select a Broker

Make Necessary Adjustments

Market Planning Summary

4

Worksheet 1: Establishing Grain and Oilseed Maximum Sales Price 5

Objectives

Worksheet 2: Establishing Grain and Oilseed Minimum Sales Price 6

Objectives

Worksheet # 3: A Checklist for Grain Market Planning

7

Unit 2. Cash Market Alternatives

8

Introduction

8

Cash Sale/Spot/Daily to Arrive

8

How Does the Spot Sale Work?

Advantages to the Spot Sale

Disadvantages to the Spot Sale

Best Time to Use the Spot Sale

Test Your Understanding of Cash Sales

The Forward Cash Contract

9

How Does the Forward Contract Work?

Advantages of Forward Contracting

Disadvantages of Forward Contracting

Best Time To Use the Forward Cash Contract

Test Your Understanding of Forward Cash Contracts

The Cash Sale with Deferred Payment

10

Advantages of the Cash Sale with Deferred Payment

Disadvantages of the Cash Sale with Deferred Payment

Test your Understanding of Cash Sales with Deferred Payment

The Minimum Price Contract

10

How Does the Minimum Price Contract Work?

Advantages to the Minimum Price Contract

Disadvantages to the Minimum Price Contract

Best Time to Use the Minimum Price Contract

Test Your Understanding of Minimum Price Contracts

Other Cash Market Alternatives

12

The Basis Contract

12

Does the Basis Contract Work?

Advantages to the Basis Contract

Disadvantages to the Basis Contract

Best Time to Use the Basis contract

The No Price Established Contract

13

The Hedge-to-Arrive Contract

13

How Does the Non-roll Hedge-to-Arrive Contract Work?

Advantages to the Non-roll Hedge-to-Arrive Contract

Disadvantages to the Non-roll Hedge-to-Arrive Contract

Best Time to Use the Hedge-to-Arrive Contract

Test Your Understanding of Other Cash Marketing Alternatives

Unit 3. Basis: The Economics of Where and When?

14

Introduction

14

Using Basis in Making Grain Marketing Decisions

15

Basis Movement

15

Factors That Affect The Basis

15

Test Your Understanding of the Basis

Basis History

16

How to Use Basis Tables; An Example

Sample Basis Table

Test Your Understanding of Basis History

Putting Basis to Work

18

Basis Summary

18

Definitions

Test Your Understanding of the Basis

Unit 4. Options on Agricultural Futures

19

Introduction

19

Why Consider Using Options as a Marketing Alternative?

20

Example 1. Net Return When Your Sell Your Crop

What is an Option?

21

Trading Options

21

Option Pricing

22

The Three Most Important Things to Remember About Option Pricing

Option Deltas

23

Test Your Understanding of Options

Margin Requirements

24

Options Used for Price Protection

24

Advantages of Options

Disadvantages of Options

Best Time to Use Options for Price Protection

Test Your Understanding of Options

Settling Options Positions

26

Example 3. Buying and Offsetting a Put Option

Test Your Understanding of Options

Exercise 1. A Strategy for Buying Put Options

Exercise 2a. A Put Option for Price Protection -- Price Declines

Exercise 2b. A Put Option for Price Protection -- Price Rises

Exercise 3. Using Options as a Tool for Weather Markets

Exercise 4. Speculative Strategy -- Buying Calls for Staying Power

Common Terms When Using Options

30

Test Your Understanding of Using Options

Unit 5. Hedging in the Futures Market

31

Introduction

31

Futures Market Basics

31

Buying, Selling, Offsetting

32

The Margin

32

Financing Margin Accounts

33

Financial Tests

33

Worksheet #1: Margining a Hedge Account

34

Hedging in the Futures Market

35

The Production Hedge

35

Example 1a. Corn Production Hedge ? Price Declines

Example 1b. Corn Production Hedge ? Price Increases

Best Time to Use the Production Hedge

The Storage Hedge

36

Figure 1. Basis Narrowing Over the Storage Period

Example 2. Storage Hedge for Corn ? Price Declines

Best Time to Use the Storage Hedge

Worksheet # 2: The Storage Hedge Decision

38

Worksheet # 3: Calculating Returns to the Storage Hedge

39

Using the Basis

Test Your Understanding of Hedging in the Futures Market

True Hedgers Versus Selective Hedgers

40

Selective Hedging

Example 3. A Double Whammy

Advantages to Hedging

Disadvantages to Hedging

Test Your Understanding of Using Hedging in the Futures Market

Example # 4: The Production Hedge

Worksheet # 4: The Production Hedge Decision

43

Types of Orders

44

Hedging Summary

44

Test Your Understanding of Hedging in the Futures Market

Exercise #1: Production Hedge Case Problem

Worksheet # 5: Production Hedge T Account

46

Exercise #2: To Store or Not to Store

Exercise # 3: The Storage Hedge

Worksheet # 6: Storage Hedge ? T Account

49

Common Terms When Hedging

50

Test Your Understanding of Hedging in the Futures Market

The Hedging Game

51

Worksheet #1: Margining a Hedge Account

56

Unit 6. Managing Financial Risk With Crop Insurance and Marketing Tools

57

Managing Risk

57

Risk to Lenders

58

Basis Risk

Quality Risk

Current Risk-management Tools

59

Yield-based insurance Products

60

CRC or RA-HPO

61

CRC or RA-HPO and Marketing

RA or IP

61

Comparison of Revenue and Yield Loss Policies

63

Market Acceptance

Limitations of Revenue Insurance

63

Revenue Insurance Basis

Quality Losses

Macro Level Market Risk

Excel Budget

64

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