Overcoming the fear of margin calls

first_imgShare Facebook Twitter Google + LinkedIn Pinterest It’s pollination week in much of the Corn Belt. In general, the weather is supportive with warm weather and adequate moisture levels. Now the focus turns to estimating the yields across the Midwest.Interestingly Kansas and South Dakota planted the same amount of acres to corn as Indiana and Ohio according to USDA forecasts. Usually Kansas and South Dakota only have state wide yields of 135 while Indiana and Ohio experience 175.Minnesota plants about 80% of the corn acres as Indiana and Ohio combined and some of the best corn in the Midwest is in Minnesota. Currently, it’s anybody’s guess as to how bad the east will be this year, but reports from the west are very encouraging.All the negative news about Illinois could be offset by potential record setting yields in Iowa where they plant 10% more acres to corn than Illinois. Nebraska is the third largest producer of corn and it might be about the only state that will be near “normal” this year.For all the concern about Missouri and to some extent Michigan, North Dakota and Wisconsin produce approximately the same amount of corn and they are having great growing conditions this year. These four states are the ninth to 12th biggest corn states and likely will continue to be in that range again this year.This certainly doesn’t guarantee that the national average for yield will remain above 166 as the USDA has estimated to this point. The corn market has a premium built into the market currently. If yields were to remain above 164 that would likely push prices below $4 again. If yields are in the 162- to 163-neighborhood then corn is justified to trade where it is currently. A drop to 160 or 161 will likely push corn futures to the high $4s and we might even see $5 per bushel again. Below 160 and the sky is the limit for futures. Fear of using the futures marketI’ve previously explained the benefits of trading futures. Today, I’ll explain the “dreaded” margin call.As a true hedger, I don’t like calling it a margin call, because that term is most often associated with speculators. A speculator making a margin call is in a bad financial situation. I’m not a speculator, I’m a hedger, and a hedger making a “margin call” is more accurately just making a finance decision. It’s not a bad thing. Let me explain further.Margin calls for hedgers are typically a net neutral (neither a gain or loss).When using the futures market to hedge grain, it doesn’t really matter if I have to make a margin call. For example: I choose to make a sell when Dec futures are $4 per bushel in June. In August, corn rallies from a weather scare and Dec corn increases to $6 per bushel. Margin call means I have to have the difference between what I have my grain sold for in futures and the current CBOT futures price. So, I will need to make a $2 per bushel margin call to my futures trading account.This part frightens farmers. That’s a lot of money. But, there is no reason to be worried, because I’m not losing that money. I harvest my grain in October and I could take the grain immediately to the local elevator, assuming the market is still the same (it doesn’t actually matter what price it is, for simplicity sake I’m leaving it the same) in October as it was in August, I could sell it for $6 per bushel. Then immediately I turn around and BUY my futures back at $6. I receive $6 per bushel on the corn delivered to the elevator. This leaves me net neutralWhen I combine my hedge account and the check for the physical grain, I lose $2 per bushel in my futures account but I still sold the corn for $6. This is where I net out $4 per bushel, which is where I originally made my sale. At the time I sold in June I thought I was making a good sale. This is the point where I get back all of my margin call money. But I don’t have cash just lying around to make margin call payments. This sounds bad.Most farmers don’t have a bunch of cash sitting around. Farmers hedging grain need to work with their bankers. For my clients, I have worked with their bankers first to set up a path for margin calls as a part of a hedging position. This is a very low risk loan for bankers, so they are usually extremely supportive.In the above example I sold futures in June and delivered at harvest (four months). If the rally didn’t start until August, it would mean a $2 per bushel loan for three months (August to October). With a typical interest rate of 5% on an operating loan, this means only 2.5 cents per bushel interest for the margin call for those three months (math = $2 x 5% / 12 months for a monthly rate x 3 months). 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, you can’t take advantage of basis levels and other premium opportunities unless you use futures contracts or Hedge To Arrive contracts (or HTA’s). For instance, in 2012 (a drought year), I received 80 cents per bushel more for my corn that I sold using futures than farmers who sold corn flat price to an end user the same day as me and took the cash price quoted. Why not use an HTA and let someone else make my margin call?I prefer to carry my own hedge because the cost of an HTA is approximately the same price as I will have in my futures brokerage and the interest on any margin call. This allows me the benefit of being able to find the end user who may be paying more for corn at or after harvest. It’s not uncommon to see end users have 10 to 20 cent pushes in their bid. I want to be able to take advantage of this premium in the market. I can’t guarantee where the best bid will be three months in advance so locking my grain up with and end user now isn’t something I want to do.Another benefit – if farmers are unable to produce corn (e.g. due to weather), it’s easier to get out of futures sales than asking end users to be let out of contracts, be it cash trades or HTA’s. Myth – Making a margin call is badMany farmers may be shocked by this, but making a margin call is a GOOD thing. Here’s why.Typically I don’t price all of my corn at any given time, and I doubt most farmers do either. I usually hold some back for potential market rallies. As described above, I have to pay margin call on my priced/sold grain with every rally. But, this means the corn I haven’t priced/sold yet is now worth more. All future unsold grain is now worth more. Since I plan to farm well into the future, I have more corn to sell, maybe not this year, but next year I will.Margin call means corn you haven’t priced/sold is worth more. Embrace it. I’m too scared of the margin call.Margin call scares most farmers the first year of futures trading. This is why I highly recommend using a marketing advisor to walk farmers through it. I always make sure that my banker understands exactly what I’m doing and what my potential borrowing needs could be.Many of my clients have expressed reservations and fear that first year when they have to cut a $5,000 to $10,000 check several weeks in a row (despite knowing they will eventually get it back). For example, a farmer raises 600 corn acres at 150 bushels per acre and hedges 50% by June 1. Say they have a $2 margin call — it could be upwards of a $90,000 margin call. That’s a lot of money. However, this farmer will be getting that money back later AND they’ll also have an opportunity at improved basis levels that their neighbor who didn’t use futures. Typically after the first year my clients wonder why they didn’t start using futures sooner.Don’t let your fear of margin calls keep you from using the biggest marketing tool there is to hedge your grain and take advantage of market opportunities. Savvy farmers understand it and use the tools that are available to increase profits and minimize risk.Jon grew up raising corn and soybeans on a farm near Beatrice, NE. Upon graduation from The University of Nebraska in Lincoln, he became a grain merchandiser and has been trading corn, soybeans and other grains for the last 18 years, building relationships with end-users in the process. After successfully marketing his father’s grain and getting his MBA, 10 years ago he started helping farmer clients market their grain based upon his principals of farmer education, reducing risk, understanding storage potential and using basis strategy to maximize individual farm operation profits. A big believer in farmer education of futures trading, Jon writes a weekly commentary to farmers interested in learning more and growing their farm operations.Trading of futures, options, swaps and other derivatives is risky and is not suitable for all persons. All of these investment products are leveraged, and you can lose more than your initial deposit. Each investment product is offered only to and from jurisdictions where solicitation and sale are lawful, and in accordance with applicable laws and regulations in such jurisdiction. The information provided here should not be relied upon as a substitute for independent research before making your investment decisions. Superior Feed Ingredients, LLC is merely providing this information for your general information and the information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision. The contents of this communication and any attachments are for informational purposes only and under no circumstances should they be construed as an offer to buy or sell, or a solicitation to buy or sell any future, option, swap or other derivative. The sources for the information and any opinions in this communication are believed to be reliable, but Superior Feed Ingredients, LLC does not warrant or guarantee the accuracy of such information or opinions. Superior Feed Ingredients, LLC and its principals and employees may take positions different from any positions described in this communication. Past results are not necessarily indicative of future results. He can be contacted at [email protected]last_img

Leave a Reply

Your email address will not be published. Required fields are marked *