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Market Commentary for 11/27/23. Why I Like Margin Calls

Jon Scheve with weekly market commentary made on November 24, 2023


Many traders take time off the week of Thanksgiving, which can sometimes lead to increased market volatility. The price action this week does not necessarily mean a trend has formed. 

 

Next week December corn futures will move into the delivery period. How the market reacts during this time will probably be more telling than what the market did this week.

 

Why I Like Margin Calls

As a true hedger, I dislike the term “margin call” because it is often associated with speculators who are in a trade that has gone wrong. 


However, I am not a speculator, I am a hedger. The difference is I produce the commodity that I have a futures sale for, which means grain marketing and risk management decisions are different. For hedgers a “margin call” is really just a financial decision, and not a bad thing. 


How Selling Futures Through A Hedge Account And Margin Call Works

Let's say in June, December corn futures are $5 per bushel, and I decide to sell futures. Then in August a weather issue pushes December corn to $6 per bushel. I would then have to make a $1 margin call in my futures account, which is the difference between the price my grain is sold for in futures, $5, and the current futures price of $6. 


This idea scares farmers because that can be a lot of money. However, there is no reason to be concerned because a farmer is not losing that money.


Why?

To answer that, let’s walk through the selling process first. We will then assume in October that I harvest my corn, take it to the elevator, and for simplicity the price is still $6. 

  • I deliver and sell corn for $6 per bushel in a cash sale to the elevator.

  • The elevator gives me a check for $6 per bushel.

  • At the exact same time I sell cash grain to the elevator for $6, I buy back futures in my hedge account for $6 per bushel.


This buying back of the futures keeps me net neutral on my hedged position from where I sold futures in June at $5. 


The most important part of this example is that when I sold the corn for a cash contract, I immediately bought the same amount of bushels in my hedge account.  If I had waited even for one second, thinking futures could go up or down, I would become a speculator. To stay a hedger, and not speculate, I must always keep my position net neutral when I sell grain for cash and have a futures position in place.


Following summarizes the trades:

  • $5 Futures sale in June – hedge account

  •  -$6 Futures buy back in October when cash grain is sold – hedge account

  •  -$1 loss – hedge account

  • $6 Cash from sale in October – check from elevator.

  • Final Price - $5 per bushel (which is exactly my original futures sale)


The extra $1 I received in the cash sale from what I originally sold futures at will pay off the margin call in full and that is how the money is finally recouped.


I Don’t Have Cash Just Lying Around to Make Margin Call Payments. This Sounds Bad.

Most farmers don’t have a lot of cash laying around, so they need to work with their bankers to hedge their grain. Most bankers are very supportive of these loans because they are low risk if farmers do them correctly. Each year I inform my banker on my potential margin call needs, so they are prepared if prices rally. Many bankers will then set up a hedging line that is separate, from the operating note.


In the example above, I sold futures in June and delivered it 4 months later. If the rally started in August, I only needed the $1 per bushel margin call loan for 3 months (August to October). With hedging loans currently at 9%, the interest cost per month is only ¾ of a cent. This means that I only have 2.25 cents per bushel in total for the margin call costs until harvest. I calculated that by taking $1 margin call x 9% interest rate / 12 months x 3-month loan).


Why Would I Even Do This Then? I Could Have Just Sold Grain to My Elevator and Not Worried About Margin Call.

If corn rallies due to a major drought, farmers can’t take advantage of increasing basis levels or spread premium opportunities unless they separate their futures sales from their basis sales.


For instance, due to the drought in 2012, I received 80 cents more per bushel, on corn that I had sold with futures, because local basis values increased significantly after harvest. Farmers using straight cash sale contracts on the same day that I sold my grain before harvest, missed out on substantial basis opportunity post-harvest.


Also in 2022, basis after harvest was nearly 80 cents better than bids the summer before. Once again cash sellers had to take the lower pre-harvest basis value and miss post-harvest opportunities.

Even in most years I see a basis rally of at least 20 cents per bushel after harvest that I can capture because I have not yet set my basis.


Why Not Use an HTA And Let Someone Else Make My Margin Call?

As I shared last week, I am not a fan of HTAs. I prefer to carry my own hedges. Some of the benefits I mentioned were:

  • The costs are about the same to hedge myself.

  • I am not locked into any one end user.

  • More marketing flexibility

 

Another benefit – it is easier to get out of sales if I am short on production. Buyers have a plan for every bushel sold to them. If producers are short, then buyers need to find someone to sell them grain to make up the difference. By then, basis values will likely be much higher, and it will be very difficult and expensive to get out of the HTA or even cash trades. Just having a futures position in place makes it easier to exit trades as I do not have to worry about basis issues with the futures contract. 

 

Myth – Making A Margin Call Is Bad

Many farmers may be shocked by this, but making a margin call can be a GOOD thing. Since margin call is only paid when the market rallies, any unpriced grain I have in the current marketing year, or the following year will be worth more.


 ***Margin call means all my unpriced corn is worth more.***


I Understand That the Math Makes Sense, But I’m Still Too Scared of Margin Call

Many of the farmers I have worked with had concerns the first year they had to make $5,000-$10,000 margin call payments in to their hedge accounts several days in a row. Even though they knew they would get the money back, it was still a lot of money.


However, once they saw all the opportunities to increase their profits with basis and spread opportunities, they felt much better. They began to see how much better they could sell their grain for than their neighbor’s, who did not use futures. Usually, after the first year they wonder why they didn’t use futures sooner.


Bottomline

I would urge farmers to not let the fear of margin calls keep them from using a marketing tool that provides so much potential for increased profits and risk management. If you are interested in switching from cash trades or HTAs, I recommend partnering with someone knowledgeable about how margin call will affect your hedge line, your bank, and your nerves. You want someone who can help you not only navigate the process, but also make you feel that you are not alone.


I talk to farmers all the time about how hedge accounts can benefit their farm operation and explain how margin calls work. So, reach out to me if you would like to know more.


Jon Scheve

Superior Feed Ingredients, LLC

9358 Oak Ave

Waconia, MN 55387

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