1. MARKETING ALTERNATIVES FOR GEORGIA FARMERS TRI-CO. YOUNG FARMER ORGANIZATION

2. INTRODUCTION GOVERNMENT POLICY CHANGE Strict regulations to market oriented system Greater risk exposure (wild swings since 1972) What to produce How much to produce When, Where, How to establish a price

3. INCREASED IMPORTANCE OF FOREIGN MARKETS Changes in value of the dollar Global weather Political situations Exports Global economies

4. GEORGIA PRODUCERS MUST UTILIZE PRODUCTION AND MARKETING PRACTICES Reduce risk Increase probability of selling crops at a profitable price

5. PLANNING AHEAD Production practices greatly improved Marketing receives too little attention Production and marketing go hand in hand in creating a successful farming operation Effective marketing requires planning ahead Where you want to go and how to get there

6. PRICE OBJECTIVE Where you want to go – the sale of crops at a profitable price (Price Objective) Be high enough to cover costs of production plus provide a reasonable return for risk and effort Price objectives will be different for each farm

7. HOW SHOULD PRICE OBJECTIVES BE DETERMINED? Don’t know the exact cost of production Use previous farm history Crop enterprise budgets

8. MARKETING STRATEGIES No one strategy is best for everyone every year – Must evaluate farm situation Ability to handle risk is key element Risk – The chance or probability of a loss or an otherwise unfavorable outcome

9. TWO TYPES OF RISK Production risk Low yields, high production costs Price risk Unfavorable market prices

10. MARKETING ALTERNATIVES ALLOW FOR PRICING UP TO ONE YEAR PRIOR TO HARVEST AND MORE THAN ONE YEAR AFTER HARVEST Marketing may include pricing portions of the crop over a period of time using more than one market alternative Reduces risk but requires more attention to market situations

11. MARKETING STRATEGIES Four things must occur for a legal transaction Goods must be delivered from seller to buyer Price must be agreed upon Transfer of legal title must occur Payment must be made from buyer to seller All create possibility of marketing alternatives

12. FORWARD PRICING ALTERNATIVES Price of the commodity is established prior to delivery to the cash market buyer Available for a year or more prior to the actual harvest and may be used after harvest

13. DELIVERY PRICING ALTERNATIVE Price determined at the time of delivery to buyer Take place at harvest or out of storage

14. DELAYED PRICING ALTERNATIVE Pricing determined at sometime after delivery to the buyer

15. FLOOR PRICING ALTERNATIVES Minimum price is established for the commodity but allows for receipt of upside price movements Commodity options Government loans

16. FORWARD PRICING ALTERNATIVES Hedging in the Futures Market Very complex and sophisticated marketing alternative Better know what you are doing Knowledge of futures market is needed to understand how prices are established for farmers

17. FUTURES MARKETS The markets are where prices are established for the future delivery of commodities Prices determined by traders making public bids and offers on the trading floor Contracts to deliver or receive a specified quantity and quality of a commodity at a specified price, place, and time in the future

18. CONTRACT OBLIGATIONS Can meet the obligation of a contract by making an opposite or offsetting transaction in the same delivery month. Sell one November soybean contract – Get out of the contract by buying one November contract before the maturity date (near the twentieth of the month) Use futures markets to shift price risk to someone else – not an actual sale and delivery of the crop (before the maturity date)

19. PRICE RELATIONSHIPS Local and futures prices generally move in the same direction but will not usually be the same amount Georgia prices tend to be higher than Iowa prices

20. BASIS The difference between local cash price and the futures market price Reasonably predictable When to use futures market – Trade risk of predicting cash price for the lesser risk of predicting the basis

21. TWO DISTINCT GROUPS OF FUTURES MARKET PARTICIPANTS Hedgers Use futures markets to establish a price of a commodity which will be delivered in the future Very few farmers hedge but most grain elevators, feed mills, etc. hedge

22. Speculators Do not wish to receive or deliver the actual cash commodity Buy and sell futures solely to profit from price changes Are important to make the futures market work Assumes price risk and allows for easy entrance and exit from the market

23. THE HEDGING PROCESS Determine price objective Large enough to cover your estimated costs of production including profit and storage costs if appropriate Localize the quoted futures price Select appropriate futures contract month Find most recent price quote for futures contract month Adjust for local market “basis”

24. HEDGING PROCESS CONTINUED Deduct the costs of using the futures market Broker commission fee (1 cent per bushel) Interest on margin account Good faith money (5 – 10% of value of contract – Returned when end contracts Annual interest fee (12% for 6 mos.) Total of about.05 per bushel

25. HEDGING PROCESS CON’T Make a decision Execute the hedge Hire a broker Deliver an order to sell contract at or above target price When harvesting crop, sell at local cash market, and deliver an order to buy a contract

26. TWO TYPES OF HEDGES Production hedge – Forward price growing crop or crop yet to be planted Storage hedge – price on stored crops which locks in return to storage

27. HEDGE EXAMPLE # 1 HANDOUT WHEN PRICES DECREASE AT HARVEST

28. HEDGE EXAMPLE # 2 HANDOUT WHEN PRICES INCREASE AT HARVEST

29. CASH FORWARD CONTRACTS AGREEMENT BETWEEN A SELLER AND A BUYER FOR A SPECIFIED QUANTITY AND QUALITY OF A CROP AT A SPECIFIED PRICE AND DELIVERY PERIOD MAIN FACTOR USED BY BUYER IN SETTING A CASH CONTRACT BID PRICE IS THE CURRENT FUTURES PRICE FOR THE MONTH NEAREST THE DELIVERY DATE (NOT BEFORE)

30. FORWARD CONTRACTS CON’T Buyer usually hedges the purchase in the futures market or immediately sells to another buyer Advantages Shift price risk to buyer Disadvantage If fail to produce may have to buy to meet commitment

31. DELIVERY PRICING Cash sale at harvest Cash sale out of storage Disadvantage Lost opportunity cost May have to take what you can get for a price at the time

32. DELAYED PRICING Price Later Contracts Commodity is delivered, title changes hands, the seller may accept the price offered by the buyer or any given day within some time period Buyer usually hedges purchase to secure price

33. DELAYED PRICING CON’T Basis Contracts Commodity is delivered Title changes hands Seller selects a futures market contract month near the date of expected sales upon which the price will be based Buyer assigns a basis to the futures contract Seller agrees to price the contract before the futures contract matures

34. Basis Contract Con’t Advantage Buyer often makes a partial payment Disadvantage Seller gives up any opportunity for basis appreciation

35. FLOOR PRICING ALTERNATIVES Establish a minimum price for a crop while retaining the ability to capture upside price movements Two Methods Government Loan Program Commodity Options

36. GOVERNMENT LOAN PROGRAM Non-recourse loans by USDA through Commodity Credit Corporation (CCC) Stored crop is collateral Generally 9 months in duration Loans sometimes extend 3-5 years through Farmer Owned Reserve Sec. Of Agriculture sets loan rates – provides a floor price

37. GOVERNMENT LOAN CON’T Grower has the option of selling the crop and repaying the loan plus interest or forfeiting the crop to the CCC in lieu of loan repayment At a minimum the grower should receive the loan rate less storage costs

38. COMMODITY OPTIONS Provides an opportunity, but not an obligation, to sell or buy a commodity at a certain price

39. COMMODITY OPTIONS CON’T Purchaser pays a premium (like insurance) to put a floor on selling price or a cap on a buying price of a commodity

40. There are two kinds of options PUTS Gives you the right, but not the obligation to go short, or sell, a futures contract upon expiration. Puts gain value as prices fall and are primarily used for planting strategies by hedgers Most hedgers close out their contracts and do not convert them to actual futures contracts If you bought a put in the spring and it gained value because prices fell, you would sell a put at the same strike price to exit your position. Profit would be the difference to be added to the cash price you received

41. SECOND KIND OF OPTION CALLS Gives you the right, but not the obligation to go long, or buy, a futures contract upon expiration. Calls gain value as the market rises and are primarily used for harvest strategies by hedgers Allow for profit from upward price movement after the sale of the commodity If your call option gained in value you would offset your position by selling a call at the same strike price. If prices went down, let option expire

42. COMMODITY OPTIONS

43. STRIKE PRICE The price at which you want your level of coverage Out of the money – not earning money yet and the premium is less expensive At the money – at the current selling price and will earn money when the market moves. The premium is average In the money – option is already earning money and the premium is most expensive

44. DETERMINING WHAT STRIKE PRICE TO CHOOSE Know your cost of production Determine how much risk you can afford to take Determine how much premium you can afford to pay

45. Strike Price – Premium = Price Floor Option Cost X Contract Size = Premium