Too often farmers have negative experiences with hedging strategies, thereby discouraging them to invest in the future. Many are unaware that these situations are largely due to improper portfolio management and a lack of understanding. By creating a strategy that includes hedging with options instead of only futures, the investor has much more flexibility and control over the cost, while also reducing risk.
The Stress of Looking to the Futures
Futures carry a larger upfront cost, as it requires the hedger to keep a significant amount of money in their account to maintain the position. Should the market move against you, more funds will need to be added. This ongoing expense can cause a great amount of stress, which is not always feasible for farmers operating under tight margins.
There are Options
Unlike hedges built with only futures, a strategy with options can provide more flexibility and less of a financial strain. Costs can be defined upfront, effectively removing the surprise of extra expenses to maintain the hedge. Additionally, positions can be established and maintained with limited cost, regardless if the market moves for or against the hedger. Should it swing against the investor, they won’t be forced to continually support a losing hedge. The investor can simply adjust the position in the market to be in a better spot to capitalize on price movements.
Hedging Properly is a Good Business Practice
Farmers hold a lot of risks, as they are at the mercy of the harvest, swinging markets and other unpredictable variables. An option hedging strategy is an intelligent way to lower the risk of existing exposure. Compared to a futures-only hedge, hedging with options is less demanding on finances. While a well-built option plan can be less of a monetary burden, a heavy emphasis should be placed on analyzing the risk tolerance of the individual or organization, as there is no one-size-fits-all master plan. (Hedging can be influenced heavily by numerous factors, such as time of the year, the position of the markets, financial risk tolerance, risk exposure, weather and much more.)
The primary goal of engaging in options strategies is to limit risk to ensure the farm remains open for business the following year.
While the fear of hedging strategies is understandable, there are plenty of reasons why every farm should engage in one. Farmers know prices rarely remain consistent, which can be stressful when planning budgets on inconsistent profits. Options hedges can reduce that risk while creating a more consistent revenue stream. A properly tailored strategy can offer protection from a downward swing in prices while creating the opportunity to reap the benefits of a price surge. It provides a competitive edge and is a viable way to reduce risk.