Futures or Cash Contracts?

The essence of selective hedging is to sell price breaks and be prepared to lift the protection if the market rallies. I have been asked if I advocate the use of futures or option contracts over cash contracts. Definitely not! Cash contracts should be in play for many producers.

I do make the case in Hedging Works that lifting futures and options contracts may be easier and more timely to execute, but only because some producers encounter resistance when asking to buy back cash contracts. Certainly buying back cash contracts is less widely used than buying and selling futures and options, but that doesn’t mean that you have to give up the use of cash contracts to do a better job of price risk management. The key is to sit down with your local grain buyer to discuss your strategy and the charges that may be associated with buying back contracts. If your local buyer is unwilling to discuss lifting cash contracts, keep shopping.

Here are a few things to keep in mind as you discuss lifting cash contracts. First, the local grain buyers want your grain so it is no surprise that they may resist letting you lift a contract. Point out that if this was your initial preference for delivery, you are most likely to contract again with the same buyer at a later date. Thus, they will get the grain and the normal fees and service charges for handling the grain.

Second, don’t be shocked when there is a charge for lifting a contract. They are providing services which allows you to not have a brokerage account, margin requirements and calls, interest charges, etc. It is reasonable to pay a small fee for the convenience and services.

Third, if executed correctly, you will be buying back a contract with a gain. Having a small charge for services deducted from your gain should not be significant.

Fourth, in the bigger picture, you need to give some serious thought to why the local grain buyers would be unwilling to allow you to buy back cash contracts when they have bought your grain at a low price and it is apparent to you that the market is going to rally. Someone along the chain is going to benefit if you are forced to deliver at that lower price.

The keys to this discussion are “willingness” and “reasonable charges” for services provided. I have heard of charges as low as zero when there is a gain in the contract (price has fallen) to 18 cents per bushel ($900 on a 5,000 bushel contract). Many brokers now offer fees of less than $100 for round turn on a futures contract, or less than 2 cents per bushel. I think the 18 cents is excessive, but give your buyer an opportunity to explain how they calculate their charge for lifting a contract. Then you will have a basis to decide if the proposed charge is reasonable for services provided.

Posted by Keith D. Rogers on 22 April 2013