Post harvest strategy for growers

With grain prices subdued at harvest and, in the case of Australian Milling Wheat (AWM), the best part of $80 per tonne (27%) lower than the prevailing price at time of sowing, many growers chose to warehouse their grain in the hope a post harvest rally might present a better selling opportunity.

Unfortunately, the post harvest rally has in many cases either not transpired to the extent desired or has not happened at all with the value of warehoused grain falling further.

The first point to make is, with the benefit of hindsight, Season 2009 (like 2008) was a year which rewarded growers who hedged through a forward sales programme. Every year is different, but a hedging programme that is managed, rather than set and forgotten, can offer growers greater control over their marketing. For instance, growers who did hedge in 2009 would not have found the decision on whether or not to sell at the subdued harvest price as uncomfortable as it may have been for others.

The second point to make is, the ASX grain futures and options contracts present growers with marketing alternatives not just before sowing and before harvest, but also during harvest as well as post harvest. While the name Futures implies marketing forward, futures contracts can be, and are, utilised once the grain is in the bin. For example, growers that grow grain within the delivery zones for ASX contracts can use the market to hedge and sell (deliver) their grain.

The below table maps the month-end settlement prices for the January 2010 (0F) and March 2010 (0H) contracts for Australian Milling Wheat (New South Wales) (AWM), and Western Australia Wheat (WAW). Looking at the prices listed, it can be seen that there was a lift in the market in November but since then prices again fell. Warehousing grain defers the timing of the sale but does not manage the risk that the market may fall further.

ASX Contract May July Sept Nov Jan* Feb^
AWM0F $296.50 $244 $201.50 $220.50 $210 N.A.
WAW0F N.A. N.A. $201 $220.50 $204 N.A.
WAW0H N.A. N.A. $198.50 $220 $202 $214.50
AWM0H $299.30 $248 $201.30 $229 $211 $212

* Settlement Price (Jan Expiry): 21 Jan 2010 ^ Settlement Price: 24 Feb 2010

The following strategy enables growers to establish a minimum price for their wheat (with a known cost), create cashflow and also retain an interest in the market should it rally after the sale has been made.

Sell Wheat and buy a Call Option Strategy

When to apply When you need cashflow but at the same time would also like to retain an interest in the market in case there is a rally after the sale is made.
How to apply 

Sell wheat (either through futures or by physical sale)

Buy call options over the relevant wheat futures contract (AWM or WAW). 
Advantages

Establishes a minimum price.

Creates cashflow.

Retains an interest in the market in case there is a rally post sale.

If there is no post sale rally, the risk of the strategy is limited to the cost of the option (premium) paid.
Disadvantages 

If there is no rally, the money invested in the option is forgone.

The timing of the rally must occur prior to the option expiry (maturity date).

The strategy will not capture the complete value of any rally. This is a risk/reward tradeoff.

The below example is based on the following assumption:

  • Grower is based within Kwinana zone, has warehoused APW2 and intends to deliver against the sold futures position.
  • This strategy can be applied by any grower in Australia. Growers in New South Wales could apply the strategy to the AWM contract instead of WAW. The first step of selling and delivering against ASX futures contracts can be replicated with a physical cash sale.
Date Strategy / Explanation Return / Cost (/t)
05 Jan 2010

Sell Wheat

Sell 100 WAW0F contracts. (2,000 t)

It is during the January delivery period, grower opts to deliver against sold contracts which effectively returns $216/t (paid T+1) and generates needed cash flow.

 $216
06 Jan 2010

Buy Call Options

Buy 100 WAW0H $230 Calls. (2,000 t)

Grower believes there is a possibility there may be a rally between now and mid Feb. Buying calls gives the grower the right to partake in the market if a rally does occur. The cost of this option was $5/t which is paid for upfront. The effective return is now $211/t ($216-$5).

 ($5)
19 Feb 2010 

WAW0H settled @ $209. March Options expiry date.

The $230 Calls (the right to buy March WAW @ $230) has therefore expired worthless.
The post sale rally has not eventuated, the final result was cashflow generated at $211/t six weeks prior to this date. WAW is now trading at $209 (another $2 less).

  $211
WHAT IF

Hypothetical

WAW0H settled @ $259 on 19 Feb 2010.

The post sale rally did occur, before the March option expiry (19 Feb 10).

The $230 Calls (the right to buy March WAW @ $230) would have been worth $29 ($259-$230).
The grower has benefited $29 from the post sale rally. The final result was cashflow generated at $211/t (6 weeks prior to this date) and the additional $29/t value of the option = $240/t. 

 $240