After the great bean crops of 1984, ‘85, ’86 and ’87, soybean futures looked like they would never get above $6 again. So, when dry weather in 1988 got November 1988 beans high enough farmers could forward contract new beans for $6.00, they did so aggressively.
I did not know farmers were contracting so aggressively. I have always done my own market research to formulate my own opinion. I have never wanted get my mind cluttered with what other analysts and farmers thought. Fortunately for me and my clients in 1988, I was expecting a bean rally and I told my clients to hold-off on new crop bean sales all winter and spring.
November 1988 beans traded to a low of $4.99 in August of 1987 and it was a slow uptrend that reached $7.00 by April of 1988 and $9.00 by June 7th. For a variety of reasons, I decided on the evening of June 22nd, it was time to price all new crop beans. November beans had settled that day at $10.10, down 3 ½ cents and was looking “toppy”.
I called my clients that evening and early the next morning before they left the house (no cell phones or email in those days) and told them to price as high a percentage of their new crop beans as their nerves could stand and do it at the market on the opening on the 23rd of June.
One of clients, Kevin, was about 31 years old with a young family and he had a lot of debt and less assets after farm land in his area went from $3400 in 1980 to $600 per acre in 1984, which was the year he became my client. Kevin did everything exactly the way I told him from the day he hired me. He could not afford any mistakes.
Around noon on the 23rd of June, 1988, Kevin called me to tell me what he went through that morning in an effort to price his beans. This is what he said:
I called Ohio Grain, but the phone line was busy, busy, busy… So, I got in my pick-up and drove to the elevator. I was surprised to see 15 or 20 pickups in the parking lot! I figured there must be some new agronomic product sales meeting that I had not read in my junk mail. I really did not think too much about it since I had no money to buy anything anyway.
I got inside and walked to the left to go to the grain merchandiser’s office and there were 15 or 16 farmers standing in line waiting their turn to talk to the merchandiser! I thought, “Wow! I had no idea Roger had so many clients!” It made me feel like I was truly doing the right thing to contract my beans the same day all my neighbors were contracting beans. It gave me a warm. fuzzy feeling inside.
I chit-chatted with some of the guys and I began to notice many of them had their check books in their pockets or were even holding a check book in their hand. I thought that was very odd… Then I noticed a guy come out of the merchandiser’s office and he was putting his check book in his shirt pocket.
I had not taken my check book when I left the house. Even if I did, I had no money in my checking account.
I was getting nervous. Perhaps the elevator’s policy had changed and there was fee to contract soybeans now, but I sure did not receive a notice about that. I had never seen $10 beans before and I was quite happy to be able contract beans for $10, but now I was really nervous I would not be able to lock-in $10 beans because I had no money to pay whatever fee the elevator was charging. It would be a continuation of my bad luck with money since I had bought my sisters out in the 1980. Me not being able to contract beans for $10 for lack of money would be just another kick-in-the-head for me to go along with the other disappointments the past eight years…
By the time I was fifth in line, I saw there were 15 to 20 more guys behind me and I could see several of them had their checkbooks.
I could not stand it anymore, so I whispered to my neighbor, Bill, in front of me, “Why do all these guys have their check books? Is there a fee to contract beans now?”
Bill got wide-eyed and was speechless for several seconds. I REALLY got antsy then!
Bill finally said, “We got our check books to get out of the bean contracts. Didn’t you get a letter yesterday?”
I thought hard about what I had got in the mail yesterday… I did not get a letter from Ohio Grain.
I said to Bill, “What letter are you talking about? From Ohio Grain? No. What did the letter say?”
Bill said, “Beans in the teens, Man! Ohio Grain said beans will surely go $14 to $15 and we should get of our contract while we can still do it for $3 or $4 a bushel. All these guys are here to buy-out their bean contracts and thank God Ohio Grain is letting us do it!”
After a long pregnant pause with my head spinning, Bill asked, “What are YOU here for?” He said it so loud, half the people in the line stopped talking and looked at me, waiting for my answer.
I mumbled, “I am here to contract beans”.
Bill asked, loudly, “What did you say?!” He was mocking me.
I took a deep gulp and said slightly louder, “I am here to contract my new crop beans.”
There was a stunned silence in my immediate area until Bill said to all famers in line, including the ones still chatting at the far end of the line, “Listen to this you Guys! Kevin is here to contract his new crop beans! Can you believe that?!”
I looked up and down the line. Some of guys started laughing. Some guys just bowed their heads and shook it from left to right. Others looked like they had just seen a ghost…
Thankfully, just about that quick, it was my turn to go into the office. As I sat down, the merchandiser said, “Kevin, I don’t remember you having any beans contracted. Let me look at the file…”
I stopped him and told him he was right, I did not have any beans contracted, but I was here to contract my beans. He was already walking to his file cabinet and he stopped and looked at me for a second and then walked to the door and yelled, “Hey, Guys, Kevin is here to contract his new crop beans!”
I heard some laughter and then someone yelled back, “Yea, we know! What an idiot!”
Kevin stopped talking. I was afraid to ask him, but I had to ask him… “Did you sell your beans?”
“Hell, yes, I sold my beans! I was not going to go through that again! Besides, I cannot afford to turn down $10 beans!”
November beans opened that day at $10.18, up 7½, the high was $10.46, the low was $9.88 and the close was $9.92. Kevin’s luck changed that day. If it had not been for that long line, his sell order would have been filled on the opening (10:30 AM Eastern Time in those days) at $10.18. But since it was about 11 AM when he got in the merchandiser’s office, his beans were sold on a HTA at $10.32. That very day was the contract high for beans that year.
Four weeks later, November beans traded down to $7.28. It would be 19 years and 6 months before November beans traded to Kevin’s selling price of $10.32 again.
That fall, November beans were in the low $7 range with a basis of about +10 cents. Most of those farmers paid Ohio Grain more than $4 a bushel to buy out their $6 beans contracts. So, they netted about $3.20 a bushel cash for their 1988 beans.
Ohio Grain convinced those farmers they were doing the farmers a favor by “letting then out” of their contracts. In reality, Ohio Grain was running out of margin money for the hedges they had on those $6 contracts.
The moral of the story is: Never, ever buy-out of a contract because it is looking too cheap. If you can’t make money at the contracted price, you made a big mistake by selling at the price. Do not compound the mistake by buying-out at a higher price. Buy a put and make the money on the way down that you did not make on the way up.
If those farmers had bought a $9.50 put for 20 cents that day (June 23rd, 1988), they could have sold that put for $2.30 before harvest and added $2.10 to their $6.00 contract price. Beans at $8.20 is a pretty good price when you initially contracted at $6.00. Instead those farmers got about $3.30.
The November 1988 bean chart:
2 July 2019 Edition of Should You Buy Out of Those Low Priced Contracts
Last winter and spring, there were many corn producers who contracted 2019 crop corn at prices that are now obviously way too cheap. When December corn was trading in the $4.50 to $4.70 range last month, farmers were easily persuaded by grain merchandisers to buy-out their corn contracts.
One such farmer contacted me. He had a forward contract in which the net hedge of December corn was at $3.90. On the day he had a conversation with his merchandiser, it was going to cost him 65 or so cents per bushel plus a 10 cent cancellation fee to buy out of the contract. Since then, I have heard about many farmerswriting checks for similar amounts to buy out of corn delivery contracts. When I was asked by farmers if they should do that, I told all of them absolutely, positively no! Why?
First of all, the price looked good when the contract was made. It must have been a price you could live with.
Secondly, no one knows what this market will do by the time that corn needs to be delivered.
Thirdly, buying grain near its contract high, especially at price not seen for six years, is not good investment.
Even for those farmers who did not get corn planted, I did not and still do not recommend they buy-out. I was sure there would be better opportunities. Little did I know that a much better opportunity would occur within two weeks of the contract high.
December 2019 corn made a contract high at $4.73 on the 17th of June. Yesterday (1 July 2019), December corn traded down to $4.20 ¾ and settled at $4.22 ½.
This sell-off started as profit-taking after the new high at $4.73 with a 24 cent sell-off and prices began to recover. On Friday, the USDA Planted Acreage Report stated 5.04 million more acres of corn were planted than the market expected. December corn traded down the 30 cent daily limit before settling down 19 ½ cents. An hour after the report was released, the USDA stated they would do a re-survey because the June 1 survey asked farmers, “How many acres of corn have you planted and intend to plant?” “Everyone” agrees that many, probably most of those “intended to be planted” corn acres on June 1st never got planted.
None-the-less, corn futures went into the dumper.
Besides writing a check to the merchandiser, what are your options when you have grain contracted and you are certain prices will go higher?
1) Ask your grain merchandiser to lift the hedge to be reestablished at a higher price. If the hedge is lifted at a 30 cent loss and re-hedged, at some price, say $5.90, the new contract price would then be $5.60 after the current 30 cent loss is deducted. The delivery obligation is maintained, therefore, legally, there is no requirement to pay the deficit.
This eliminates the need to take cash out of your cash flow.
This gives you the same opportunity to benefit from higher prices as if you had bought out the contract.
This provides the merchandiser relief from having to pay margin calls on the hedge for your corn if December corn goes to the high $7 range. In 2012, December corn went to $8.49.
2) Covert your grain delivery contract to a Minimum Price Contract, which are common-place now days. If the elevator hedge is at $3.90, you instruct the merchandiser to buy a December call option. The cost of which will be deducted from the $3.90 hedge. When the call is sold, that income will be added to the contracted hedge price.
For example, if the hedge is at $3.90 and you have the merchandiser buy a December $4.20 call for 30 cents (trading at 27 cents now), the net hedge price will be reduced by cost of the call, in this case, your minimum price will be $3.60. That December call can be sold any day you choose between now and November 22nd to give you a shot at picking the high day to sell that call option.
Let’s say December corn gets to $8.49 like it did 2012 and you sell the $4.20 call that day. It will be worth about $4.29 ($8.49 futures price minus $4.20, the strike price of the call = $4.29. The merchandiser adds $4.29 to your minimum price of $3.60. Now your net hedge price is $7.89. Again, no money out of your cash flow until the corn is delivered. You can probably live with $7.89 + or – the basis for your corn.
One last thing. If you write a check to pay the losses on liquidated hedge plus a service or cancellations fee, you and your merchandiser are violating the Commodity Exchange Act.
Why? Because that hedge quit being a hedge when you wrote the check. It was a futures transaction because no grain was delivered. All futures trades must be done on a Federal government regulated futures exchange. That federal agency is the Commodity Futures trading Commission (CFTC). Your grain elevator is regulated by your state’s Department of Agriculture, not the CFTC.
The CFTC does allow cash settlement of some grain delivery contracts in which delivery would be “extremely” difficult due to unforeseen circumstances. Perhaps no corn planted would qualify. But I assure you, buying-out a contract because the price is low does not qualify. Buying out a contract if you had a crop failure does qualify, but don’t do that; roll the HTA to the next crop year.
January 2020 Update on 2019 Corn Market Action
To pound home the point that no one knows what the market will do, and therefore, one should never buy-out of delivery contract, December 2019 corn made its low on September 9th at $3.52¼.
That $3.90 delivery contract did not look so bad the last four months of 2019. The December 2019 corn chart: