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Market Matters Blog           11/24 10:11

   Is It Time to Build a Fence?

   A "fence" strategy could help farmers take advantage of some of the 
uncertainty during the next few months but still allows some protection to the 
downside and a shot at higher prices.

Dana Mantini
Senior Market Analyst

   Corn futures have now rallied more than $1.00 from early August lows and the 
once very bearish outlook for new crop corn has changed dramatically. While the 
once lofty ending stocks projections of 3.0 billion bushels (bb) to 3.2 bb of 
corn in the spring have fallen by the wayside due to drought, derecho winds and 
an insatiable appetite from China, perhaps it's time to consider a new 
marketing strategy for recently harvested corn.

   U.S. ending stocks are now forecast at 1.702 bb -- nearly cut in half from 
springtime projections, but still a comfortable supply. In order to arrive at 
that carryout, the World Agricultural Supply and Demand Estimates (WASDE) 
report increased corn exports to a record large 2.650 bb.

   Granted, China has come in and bought over 10 million metric tons (394 
million bushels) of U.S. corn and some analysts think China could buy much more 
by year's end. However, for the past few weeks, U.S. corn shipments have lagged 
the weekly average needed to attain the lofty export projection; we have seen 
some for unknown destination, but no new sales for China.

   Price comparisons favor U.S. farmers and corn exporters, as both Brazilian 
and Chinese internal prices just reached record highs while Ukraine's crop has 
been decimated by dryness. As of Nov. 23, U.S. corn is cheaper than both 
Ukraine and Argentina. The U.S. is well-positioned to garner much of the new 
corn business in coming months, but there is no guarantee as to how much China 
will buy or how South American weather will turn out.

   With corn prices rising, farmers may have become reluctant to sell more corn 
until they see if China buys more or if South American dryness continues. This 
may be a good time to consider protecting the gains corn prices have made, 
while still allowing room for upside gains. The funds maintain a dangerously 
long position and long-term weather, as well as China, is hard to predict.

   There is one marketing strategy that can take advantage of some of the 
uncertainty during the next few months but still allow farmers some protection 
to the downside and a shot at higher prices. It is referred to as a "fence" 
strategy. In short, a farmer owns cash corn and buys a near the money put while 
simultaneously selling an out of the money call. The strategy has a modest net 
cost and limits downside risk, while offering more upside to a farmer's cash 
ownership.

   As an example, take a look at May 2021 options, which don't expire until 
April 23, 2021, or roughly five months from now. With May 2021 corn futures 
trading at $4.36, a $4.20 put would cost 18 1/2 cents, while a $4.80 call is 
valued at 16 1/2 cents. If a producer bought the $4.20 may put and sold the 
$4.80 May call simultaneously, the net cost of that fence strategy would be 2 
cents (debit). Let's assume that the basis for one location is 10 cents under 
the May contact for spring delivery.

   If a farmer does this on his own, at a brokerage firm, he will be 
responsible to maintain the margin requirement, which could become substantial 
if corn prices trade significantly higher. Talk to your local co-op or cash 
grain firm, however, as many can offer the same fence strategy without putting 
you on the hook for margin.

   By executing the simultaneous purchase of the $4.20 put and sale of the 
$4.80 call, the range of cash prices from worst to best would be $4.08 to 
$4.68. The $4.08 reflects the $4.20 put strike price, less the 2-cent debit for 
the option strategy and the 10-cent under basis, as the $4.20 put strike less 
$0.12 equals $4.08. On the upside, the $4.80 strike of the sold call, less 
$0.12 would be $4.68. I am assuming a farmer only enters a portion of his 
unsold crop in the fence.

   The net effect of the fence strategy explained above is that the farmer has 
a chance to sell his/her corn at a maximum of $4.68 per bushel or is protected 
with a minimum cash sale of $4.08 on the downside, assuming the farmer locks in 
the basis at 10 cents under or that it doesn't change. That would compare to 
the current cash price of $4.26 ($4.36 May futures less 10-cent under basis).

   Rather than speculate on where the market might go with an outright long 
cash position, this strategy protects much of the downside, while still 
allowing more than 40 cents upside, for minimal cost.

   Granted, if the South American drought worsens and production in South 
America is threatened, and China does return to buy significant quantities of 
additional U.S. corn, then surely May corn futures could exceed $4.80. However, 
at this stage, that is mere speculation. If rains should come and China does 
not appear, or if COVID-19 again accelerates to negatively impact demand, then 
the overweight speculative long in corn could lead to a sharp correction.

   This is simply a marketing idea, but if you are bullish to a certain extent 
-- and you understand the downside risk -- then this might be a strategy for 
you to consider on part of your recently harvested bushels.

   **

   Editor's Note: Comments above are for educational purposes and are not meant 
to be specific trade recommendations. The buying and selling of livestock and 
livestock futures involve substantial risk and are not suitable for everyone.

   Dana Mantini can be reached at dana.mantini@dtn.com

   Follow him on Twitter @mantini_r




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