At our Ag Economic Symposium this year we had two separate segments on “Structured Products.” One session as an alternative risk management tool in the equity/investment world given by Blake Allen of Pinion, and one session that I delivered about structured products as a tool for buying/selling ag commodities like your corn and soybeans.
One aspect of this seminar that I really like is that there are a lot of “bigger picture” discussions, and that leads to bigger picture thinking. It occurred to me that structured just might be the future of commodity price risk management.
We all know the benefits of using futures and options. Flexibility. Agility. Custom risk profiles. And we all know the downsides too. Margin calls and emotions. Accidentally moving from hedging, to “hedgulating”, to full-on speculating. Bottom line is that for many, the daily P&L causes them to lose sight of the hedging aspect. We can easily find ourselves getting in and out of positions without accomplishing our goal: pricing the grain.
That is where structured products that we now offer producers can come into play. Think of these as an HTA, but the price has not been set yet. The structure you choose establishes the futures price over time, and at the end of that time you have an HTA. Before, during, or after this pricing period you set the basis at the delivery location of your choice, and now you have a cash contract.
There is no up-front cost and no risk of a margin call. There are fees of course, which are deducted from your cash price, and quite reasonable. Depending on your perspective, the advantage/disadvantage of these is that you are committing actual bushels. You don’t trade these like a futures position, or like a put option. At the end of the day, these bushels are going to be priced, and you’re committed to delivering bushels against the contract. This avoids the all-too-common scenario of: Buy a put, watch the market go up, don’t make a cash sale, and watch the market come back down.
Let’s go through an example of one of the most conservative and simple structures, the Flex Floor.
Flex Floor
This is the structured product version of the put option. Let’s consider December 2026 futures, currently trading at $4.65. If you do a FlexFloor, each week the market settles below $4.65, bushels are priced at $4.65. Each week the market settles above $4.65, bushels are priced at that settlement price. The price accumulates over time, and in the end the bushels are priced. Your net price is then the average of all these sales, less the cost of the contract.
Let’s consider a couple of different scenarios and how that would play out.
Scenario 1 – the market collapses and never trades above $4.65 again. The put option expires in the money and assigns you short futures at $4.65, you paid 30¢ for that, so you are net short Dec. 26 at $4.35. This was all on paper, you still need to do something with that short futures position, and you still need to sell the grain.
If you did a FlexFloor that cost 20¢, all sales were made at $4.65. You have an HTA at $4.45 and all you need to do is set the basis and delivery location. This is the easy comparison.
Scenario 2 – the market rallies for a few months, then comes down. With the FlexFloor, each week the market settles above $4.65, the contract automatically prices bushels at the settlement price, whatever that is. Then each week the market settles under $4.65, you’re pricing bushels at $4.65. At the end of the day, all of the bushels are priced into an HTA.
The put option in this scenario has some pros and cons. Holding a put instead of FlexFloor would have allowed you to make a cash sale at the higher prices and then sell the put for a loss. Perhaps this nets you a higher price. On the flip side, perhaps the market rallied and came back without you making a sale; in that case, the FlexFloor captured more of the rally and cost less in the first place.
As with any other strategy comparison, determining which one is better typically depends more on the person and their tendencies than it does the market itself.
A current example to consider.
Let’s say you want to sell some new-crop soybeans, but you’re not convinced futures are done rallying. Short futures are a scary proposition, you participate in no further upside, and after all $11.30 is a good price for your first cash sale. Rather than an outright cash sale or HTA, consider a FlexFloor that runs from March 2 through March 27. Let’s say it’s 8,000 bushels, and accumulates bushels weekly, with 4 weeks that would be 2,000 bushels a week. The cost is approximately 15¢.
Each Friday this contract will price 2,000 bushels. If settlement is under $11.30, 2,000 bushels are priced at $11.30. The next week say futures settle at $11.60, so 2,000 bushels are priced at $11.60. If the next two weekly expirations are at $11.80 and $12.00, 2,000 bushels are sold at each of those levels, and your average price is $11.67 ½. Deduct the 15¢ fee, and you have a Nov. 26 HTA for $11.52 ½. If instead the market sells off and closes under $11.30 all four weeks, you will have a Nov. 26 HTA for $11.15. All sales were made at $11.30 and the contract costs 15¢.
So that is just the FlexFloor, what else can we offer? We can do basic HTA contracts. We can do Accumulators with or without Double Ups and Knock Outs, averaging contracts, and about a dozen others. These can be built as buying or selling contracts. The tenor, or duration, can be adjusted. Accumulation can be daily or weekly.
The bottom line is this is a very functional and flexible tool that I believe will become commonplace in the agriculture risk management world over the next few years. You get some of the advantages that futures and options offer, without the margin or stress, and ultimately the bushels are priced into a cash contract.
If this is something you would like to learn more about, please send me an email. I will be doing a couple of webinars over the coming weeks explaining how this works and highlighting some structures that look attractive to me for producers to consider.
Email David@dbrock@brockreport.com
