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Message
Question about commodity futures
Posted on 7/24/08 at 9:45 am
Posted on 7/24/08 at 9:45 am
So let's say farmer John is laying out his budget for the up coming year. He wants to know what he's going to get for his corn ahead of time, so he takes a futures contract to sell his corn at a predetermined price after harvest.
Let's say the contract is made at $2.00 a bushel for 10000 bushels.
Scenario 1
Farmer John take in his harvest. When he goes to market to sell, corn is at $1.50 a bushel. So the cash settlement of the futures contract nets him +$0.50 and the selling of the corn nets him $1.50 - he's made $2.00 a bushel.
Scenario 2
Farmer John take in his harvest. When he goes to market to sell, corn is at $2.75 a bushel. So he has to pay the futures contract holder $0.75 and he then sells his corn on the market for $2.75, netting $2.00 a bushel.
OK, so here's the question.
Scenario 3
Farmer John's harvest fails due to, I dunno, whatever can cause a crop to fail. He has 0 bushels. Corn is at $3.75 a bushel. So he has to pay the futures contract holder $1.75 a bushel for 10000 bushels. He's out $17,500 and has no corn to sell on the market.
How do farmers in real life prevent Scenario 3? Is there insurance they can buy that will pay the settlement of future? Or is there a contract they can make with an inverstor that says "If, and only if, my crop fails, this futures contract becomes your contract, and whatever gains or losses from it are yours to deal with?" Do they buy puts on their futures as insurance?
Let's say the contract is made at $2.00 a bushel for 10000 bushels.
Scenario 1
Farmer John take in his harvest. When he goes to market to sell, corn is at $1.50 a bushel. So the cash settlement of the futures contract nets him +$0.50 and the selling of the corn nets him $1.50 - he's made $2.00 a bushel.
Scenario 2
Farmer John take in his harvest. When he goes to market to sell, corn is at $2.75 a bushel. So he has to pay the futures contract holder $0.75 and he then sells his corn on the market for $2.75, netting $2.00 a bushel.
OK, so here's the question.
Scenario 3
Farmer John's harvest fails due to, I dunno, whatever can cause a crop to fail. He has 0 bushels. Corn is at $3.75 a bushel. So he has to pay the futures contract holder $1.75 a bushel for 10000 bushels. He's out $17,500 and has no corn to sell on the market.
How do farmers in real life prevent Scenario 3? Is there insurance they can buy that will pay the settlement of future? Or is there a contract they can make with an inverstor that says "If, and only if, my crop fails, this futures contract becomes your contract, and whatever gains or losses from it are yours to deal with?" Do they buy puts on their futures as insurance?
This post was edited on 7/24/08 at 9:47 am
5
Posted on 7/24/08 at 10:05 am to BillyCannonFan
I would imagine that there is disaster insurance that would simply pay market value, so he would get $3.75 per bushel from the insurance company, and would have to pay the futures holder $1.75 per bushel, once again putting him back at $2.00 per bushel.
Just a guess. I don't know.
Just a guess. I don't know.
Posted on 7/24/08 at 10:39 am to BillyCannonFan
Farmers can (and usually do) buy Crop Insurance. And there are many different categories based on what they want to be covered for (yield, price, natural disaster, etc.).
In your scenario, there are cases where they could come out with $20k, based on what they are set up for, but it's more likely they would end up some amount short, but not completely lost.
In your scenario, there are cases where they could come out with $20k, based on what they are set up for, but it's more likely they would end up some amount short, but not completely lost.
Posted on 7/24/08 at 10:59 am to TheLittleAristotle
You are neglecting to figure the basis which right now is killing the farmers. Huge unprecedented negative basis on most farm commodities. Crop insurance is a hedge against disaster but leaves alot to be desired.
Posted on 7/24/08 at 11:14 am to TheLittleAristotle
quote:
"In the last five years I have predicted LSU to go 76-0 and they have gone 66-10, and I will take that any day." - DD
Posted on 7/24/08 at 7:50 pm to TheLittleAristotle
quote:
In your scenario, there are cases where they could come out with $20k, based on what they are set up for, but it's more likely they would end up some amount short, but not completely lost.
exactly right...this is why farmers always "book" a lower amount of crop than they expect to produce....
farmers have to sink a heck of a lot of work and money into their crop without really having an idea of what their income will be....
hedging is a way of removing some of the unknown factors ahead of time....it is typically not used to gamble with the crop in hopes of striking it rich....
Posted on 7/24/08 at 9:18 pm to BillyCannonFan
Futures help farmers but aren't complete, all universal insurance. It's like a covered call - you aren't guaranteed to be even but it helps a lot.
By the way, you forgot Scenario 4 - Farmer John's harvest fails. Fortunately, the market for corn has collapsed to $0.35 a bushel and Farmer John gets to laugh his way to the bank anyway.
By the way, you forgot Scenario 4 - Farmer John's harvest fails. Fortunately, the market for corn has collapsed to $0.35 a bushel and Farmer John gets to laugh his way to the bank anyway.
Posted on 7/24/08 at 10:26 pm to BillyCannonFan
OK, so I didn't read all of this with the scenarios but YES there is crop insurance. My husband is a rice farmer and we have HAD to buy disaster insurance as a participant in the USDA programs ... which you HAVE to complete all kinds of paperwork. (Don't start bashing here about the farm bill please .. I'm just answering the question.)
We also have GRAIN/PRODUCE policies ($$$) that cover anything OTHER than perils while in the field .. say a truck overturns, or rice gets stack burn when in the dryers.
Regarding the scenarios, we have a certain amount of rice "contracted" for this harvest season for x $. It's actually a written contract from what my husband tells me (I stay out of it as much as possible .. too many big $$$ for me) and it's "supposed" to be guaranteed no matter the price at harvest. This is the first time we've ever done that with rice ... and we're planting soybeans for the first time but it's typical to "book" beans.
And yes, to whomever said that farmers put a heck of a lot of work into it is right. It's a great life (he can fish if his work is caught up and he doesn't have to ask the boss!) BUT it can REALLY SUCK at times too ...
"If you're bitching with your mouth full, thank a farmer" .. one of my personal favorite non-LSU bumper stickers!
We also have GRAIN/PRODUCE policies ($$$) that cover anything OTHER than perils while in the field .. say a truck overturns, or rice gets stack burn when in the dryers.
Regarding the scenarios, we have a certain amount of rice "contracted" for this harvest season for x $. It's actually a written contract from what my husband tells me (I stay out of it as much as possible .. too many big $$$ for me) and it's "supposed" to be guaranteed no matter the price at harvest. This is the first time we've ever done that with rice ... and we're planting soybeans for the first time but it's typical to "book" beans.
And yes, to whomever said that farmers put a heck of a lot of work into it is right. It's a great life (he can fish if his work is caught up and he doesn't have to ask the boss!) BUT it can REALLY SUCK at times too ...
"If you're bitching with your mouth full, thank a farmer" .. one of my personal favorite non-LSU bumper stickers!
Posted on 7/24/08 at 10:30 pm to BillyCannonFan
quote:
whatever can cause a crop to fail.
That would be too much rain, not enough rain, spraying wrong fungicides/pesticides or perhaps in the wrong quantity, accidental burning of field, lightning strike or electrical failure to a grain bin used for drying, ... too many for me to name and worry about!
EAT MORE RICE! I'm sure as hell hoping that my husband is done with harvest prior to the first game ... I've already told him I'm going regardless; I'm leaving him here ... although I will make his luch before I leave!!!
Posted on 7/25/08 at 9:29 am to foshizzle
quote:
By the way, you forgot Scenario 4 - Farmer John's harvest fails. Fortunately, the market for corn has collapsed to $0.35 a bushel and Farmer John gets to laugh his way to the bank anyway.
That would be the most unlikely of scenarios. If Farmer John's crop fails, then Farmer Bob down the road, his crop probably didn't come out too good either for similar reasons, so corn would be scarcer and prices driven higher.
Posted on 7/25/08 at 9:31 am to tiger91
quote:
EAT MORE RICE! I'm sure as hell hoping that my husband is done with harvest prior to the first game ... I've already told him I'm going regardless; I'm leaving him here ... although I will make his luch before I leave!!!
We eat lots of rice. Mostly louisiana rice.
Posted on 7/25/08 at 9:45 am to BillyCannonFan
Tiger 91. Our rice basis long grain is currently about -$2.25. Just wondering how it's running down there.
Posted on 7/25/08 at 10:24 am to bovine1
quote:down from what? Typically my husband gets the pricing changes/charts from the Cooperative Extension Service. We heard of people selling for more than $32/barrel last year ..
-$2.25
Do you have grain produce policy? If so who's it through???
Posted on 7/25/08 at 10:58 am to tiger91
Oh I forgot ya'll sold by the barrel down there. Up here our quotes are in bushels. $2.25 off of $7-8 bushel rice is a lot.
Posted on 7/25/08 at 11:30 am to bovine1
So to show how little I REALLY know ... how many bushels are there in a barrel? My husband talks in "hundred weight" and then I x by 1.62 to get the per barrel price. Here it WAS $35 at some point in the late spring ... AFTER we sold! Oh, well ...
Where are you located? Are you a rice farmer?
Where are you located? Are you a rice farmer?
Posted on 7/25/08 at 11:31 am to tiger91
Oops .. see it .. ArKANSAS! How are your crops looking??? We'll be ready to harvest next week ... damn hybrids do really well BUT they take a little more growing time ... we used to cut beginning in MidJuly and were ALWAYS done by the LSU season opener ... it's in question this year.
Posted on 7/25/08 at 12:58 pm to tiger91
Our rice is 1-2 months late cause of extreme spring rain. We'll probably start cutting rice around Sept. 20 or so. Big Blue quotes rice by the hundred as well and we divide it to get bushels.We also had a Newpath shortage that lasted about a week and a half. It's been a frustating year but then that's farming.
Posted on 7/25/08 at 3:57 pm to bovine1
quote:
$2.25 off of $7-8 bushel rice
So that's like $21-$24 -- 11 year old son informed me that there are 3 bushels to 1 barrel. He's so smart.
Yeah, the commodity market price is $16.7 per 100 wt so $27 per barrel ...
Posted on 7/25/08 at 7:09 pm to BillyCannonFan
quote:
By the way, you forgot Scenario 4 - Farmer John's harvest fails. Fortunately, the market for corn has collapsed to $0.35 a bushel and Farmer John gets to laugh his way to the bank anyway.
That would be the most unlikely of scenarios. If Farmer John's crop fails, then Farmer Bob down the road, his crop probably didn't come out too good either for similar reasons, so corn would be scarcer and prices driven higher.
Not a bad point, I hadn't thought about that. That said, if Farmer John's (and Bob's) crop fails, there's a decent chance Farmer Wang Chung on the other side of the planet did okay.
And vice-versa. The market for any particular farmer is local, the commodities market is global.
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