Risk Management 101 – Part 1

Sep 26, 2023 | Uncategorized

Every morning when you blink your eyes open and roll out of bed, you are taking on some amount of risk. Even the most cautious and careful person lives with risk each day (and we’re not talking about the frustrating board game that’s been around since the ‘50’s).

You risk burning your hand on the stove while you make your over-easy eggs; you risk a fender bender as you drive to drop your kids off (it’s always the other drivers we’re worried about…); you risk your retirement in the stock market; your relationships, your reputation, your health, and the list goes on

You get the idea.

Well, farmers and ranchers have market risk and that’s how you make a living in ag. I wanted to learn more about managing that risk, so I sought out an expert. I found a gentleman passionate about educating folks on what Risk Management is, and lucky you, he’s an Endorsed Service Provider (ESP) willing to share his knowledge with all of us.

Meet Devin Patton… he grew up on a commercial cow/calf operation in Oregon and now is a Series 3 Licensed Broker who also sells Livestock Risk Insurance. Living at the foot of the Wallowa Mountains with his wife and four kiddos, he’s passionate about educating the Ag community about Market Risk Management.

Here’s his thoughts:

The term Risk Management (RM) refers to market risk. First, you must understand that you carry market risk. Farmers are perpetually Long their crop market. RM is simply managing your Long position by making it smaller, or leaving it as large as it naturally is.

For crop marketing, the most simple choice is to make cash sales after your crop is harvested and stored. Or, you can be as complex as utilizing hedge-to-arrives (HTA’s) and Basis Contracts, hedging with Futures, or using Options on Futures.

Most farmers understand selling their physical crop to the elevator, so let’s learn about futures contracts.

A futures contract is a contract with specifications that is easily bought or sold via an exchange like the Chicago Board of Trade or the Chicago Mercantile Exchange. For example, a corn futures contract is for 5,000 bushels of Number 2 yellow corn. Each commodity futures contract has a specific quantity and quality grade for the par value.

Most futures contracts are deliverable, which means there are times where it might be advantageous for an owner of the commodity to deliver on their Short position. This is important to maintain a real tether between the futures prices and the price at which the physical commodities are trading.

Taking a Short position on a futures contract (short hedging) means you have gone from being Long your physical crop, to being Neutral the market.

The futures contract offsets any change in your physical crop value. If the market price falls, your hedge will profit, and your crop value will decrease. Likewise, if the market rises then your crop value will increase and be offset by losses on your futures hedge.

You May Also Like