cotton / rice risk management & marketing strategies carl anderson texas a&m university
TRANSCRIPT
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Cotton / Rice Risk Cotton / Rice Risk Management & Marketing Management & Marketing
StrategiesStrategies
Carl Anderson
Texas A&M University
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Plan to Manage Price RiskPlan to Manage Price Risk
Producers control when & how to price
Prices are volatile– Cotton price can vary by 75 % from
season to seasonMarketing plan is essential
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Markets are not going to GIVEyou anything; TAKE pricing opportunities from the market
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Marketing PlanMarketing Plan
Financial condition Estimated costs (Breakeven Price) Develop market expectations Pricing alternatives Discipline Consider worst case scenario Risk bearing ability Cash flow needs Implement your plan
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Understand MarketUnderstand Market
Supply / DemandBasic patternsSeasonal variation– high for 13 out of last 16 years
between May and September– but 7 of the 13 in year prior to harvest
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Cotton Futures High & Low Cotton Futures High & Low Prices (1980-1997)Prices (1980-1997)
0
20
40
60
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100
1201980
82
84
86
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92
94
96
Year
Cen
ts /
Lb
.
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OptionsOptions
Offer additional flexibilityUsed alone, with forward contracts
& with futures– eg., hedging with put options allow
upside opportunities
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Pricing AlternativesPricing Alternatives(1997 Crop Example)(1997 Crop Example)
Pre-harvest: (between January & August)1. Buying put2. Forward contract3. Forward contract & Buy call4. Synthetic put - Sell futures & buy call5. Sell futures6. Buy put & Sell call
Harvest:7. Sell at harvest & buy call
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1. Buying Put for 1997 Crop1. Buying Put for 1997 Crop
Buy Dec ’97 put cents/ lbStrike price 78.00Premium - 3.75Basis - 5.00Net (excluding commissions) 69.25
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1. Buying Put for 1997 Crop1. Buying Put for 1997 Crop
Result: Downside price move covered
Advantages: Benefit from price increase, no margin deposit, easy to use
Disadvantages: Premium cost, fixed quantities,basis risk, commission fees
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2. Forward Contract2. Forward Contract
cents/ lbFutures price 78.00Basis - 5.00Net (excluding commissions) 73.00
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2. Forward Contract2. Forward Contract
Result: Fixed price
Advantages: Easy, no margin deposit, no brokerage fees, flexible quantity, avoid storage costs
Disadvantages: Limits gain, not flexible once signed, local contractor may not exist, payment hinges on solvency of contractor
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3. Forward Contract & Buy 3. Forward Contract & Buy CallCall
cents/ lbForward contract 73.00
(as in #2)Premium Dec ’97, 78 call - 4.00Net (excluding commissions) 69.00
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3. Forward Contract & Buy 3. Forward Contract & Buy CallCall
Result: Minimum price contract, floor set, potential for higher price
Advantages: Minimum price helps in obtaining credit, no margin calls
Disadvantages: Premium payment required, brokerage fees, may lose time value
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4. Synthetic Put - Sell futures 4. Synthetic Put - Sell futures & Buy Call& Buy Call
cents/ lbSell Dec’97 futures 78.00Basis - 5.00Premium Dec’97, 78 call - 4.00Net (excluding commissions) 69.00
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4. Synthetic Put - Sell futures 4. Synthetic Put - Sell futures & Buy Call& Buy Call
Result: Protection from price drop, upside protected from margin costs
Advantages: Protect margin risk, may cost less than a put, flexibility
Disadvantages: Margin deposit and possible margin calls, fixed price level
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5. Sell Futures5. Sell Futures
cents/ lbSell Dec’97 futures 78.00Basis - 5.00Net (excluding commissions) 73.00
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5. Sell Futures5. Sell Futures
Result: Establishes price subject to basis variationAdvantages: Reduces risk of price decline, many buyers, formal exchange rules
Disadvantages: Limits gain, margin deposit, basis risk, brokerage fees, standardized quantity
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6. Buy Put-Sell Call for 1997 6. Buy Put-Sell Call for 1997 Crop WindowCrop Window
Cents / lbPremium, buy ’97, 78 put -3.75Sell ’97, 84 call +1.75Net (excluding commissions) -2.00
Min selling price = (78.00-3.75-5.00)+1.75 = 71.00Max selling price = (84.00-5.00)-2.00 = 77.00
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6. Buy Put-Sell Call for 1997 6. Buy Put-Sell Call for 1997 Crop WindowCrop Window
Result: Both a ceiling and floor price
Advantages: Best when prices are likely peaking, lowers cost of options, higher minimum price
Disadvantages: Margin deposit required, basis risk, ceiling unless further action, brokerage fees
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7. Sell at Harvest, Buy Call 7. Sell at Harvest, Buy Call OptionOption
Marketing Alternative: Sell crop instead of storing and purchase call option
Example Cents / lbCash price in November $0.65July $0.70 call premium -0.035Net to farmer $0.615
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7. Sell at Harvest, Buy Call 7. Sell at Harvest, Buy Call OptionOption
$ 0.0080 (80 points) per pound per month for holding costs (estimated holding costs per bale per month, $2.25 for interest, $1.75 for storage; $4.00 per month total holding costs divided by 500 pounds per bale)
$3.50 Call premium = 4.38 months for 80 points/lbs./mth./storgae storage costs to
equal to premium cost of option
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7. Sell at Harvest, Buy Call 7. Sell at Harvest, Buy Call OptionOption
Advantages: No storage cost, benefit from price increase, no margin calls, can “roll” to distant futures, flexible
Disadvantages: Premium & brokerage costs, fixed expiration, fixed contract size, quality may differ from futures