Risk Management Tools for Crops: Spreadsheets for Market Risk Management Clarity

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Risk Management Tools for
Crops: Spreadsheets for Market
Risk Management Clarity
Presentation at:
2000 Southern Region Agricultural Outlook Conference
Atlanta, GA, September 25-27, 2000
Presented by:
Charles Curtis, Jr.
Extension Agricultural Economist
Clemson University
Risk Management Tools for Crops: Spreadsheets for Market
Risk Management Clarity
Charles Curtis, Jr.
Extension Ag Economist
Clemson University
After several years of conducting standard crops marketing workshops, I
became frustrated with trying to adequately help agribusinesses wade
through the swamp of computations necessary to review (as our research
colleagues would put it) “M” alternative marketing strategies over the “N”
potential price outcomes in the future. After all, one of the reasons my
audience attended was to gain some insight into which of the “M”
alternatives (or combination thereof) might be worth considering now.
Further, I found that the timing of this part of a typical workshop was at
the end. A summary of concepts was necessary but the audience’s capacity
to absorb much more was limited. I felt I was simply asking too much of
the typical farmer after six to eight hours of an intensive workshop. We
had intensively shown them the “trees.” The frustration came in trying to
finalize a view of the “forest.”
Basic Strategy Review
I needed help in bring the experience back around to seeing all the tools
available and how they would work as the market moved. We had looked at
the “M” marketing alternative “trees” in depth. As an example, let’s look at
what we’d typically covered on hedging – just one of the alternative “trees”
in the “forest.” What are futures contracts and markets? What’s hedging
as compared to speculation? What’s a margin call? How does basis movement
interact with the hedge strategy? How do you calculate the results of a
hedging strategy if the market goes up? What if the market goes down?
What if the basis strengthened or weakened? What are the advantages &
disadvantages of hedging? In my book, that’s a detailed look at one tree!
Then you throw in the rest of the “trees;” cash forward contracting, basis
contracting, minimum price contracting, hedge-to-arrive contracts, delayed
pricing contracts, purchasing put options, buying call options to re-open the
top. How do you calculate the results of these strategies if the market goes
up or goes down? That’s a lot to remember if some or all of this was new to
you today. (After all, don’t we spend the better part of a semester on this
with college kids?) I felt something additional was needed.
The answer I hit upon was neither earth-shatteringly brilliant nor unique. It
was as simple as recognizing that my “students” could better concentrate on
the “forest” concepts if they were freed from the burdensome nature of
worrying about every “tree. “ So I let the computer help. I wrote a few
crop-specific spreadsheets that remove the mundane calculations and allows
a look at the results of a series of strategies at differing price outcomes.
The spreadsheets are designed with an input section in which the user can
place today’s relevant market information. These data are necessary to
calculate price that a given strategy will yield. All strategies are preharvest strategies. The strategy list examined by the spreadsheet is not
“all inclusive” but includes:
1.
2.
3.
4.
5.
6.
Cash sale at harvest
Basis contract now and sell at harvest
Short Hedge
Cash Forward Contract
Put option purchase
Call option purchase with a Cash Forward Contract
Results of these six basic marketing strategies are computed over a
range of eleven potential price outcomes at harvest; five lower price
scenarios, one scenario of prices staying the same and five higher price
scenarios.
The resultant table is structured:
Price Down
Strategy 1
:
Strategy 6
The data are also graphed.

Price the Same
Strategy
M/Price N

Price Up
A Work in Progress
The original strategy spreadsheets developed have been modified and
enhanced numerous times. The matrix discussed above provides
objective information on what will happen if following strategy M as
prices change to varying degrees. One subsequent addition made has
been to add information on the probability of prices changes. This idea
was borrowed from George Shumaker and John McKissick of the
University of Georgia who pioneered much of the integration and use of
price probability into market strategy choice. From them, I hit on the
idea of adding price probabilities derived from the current options
market. Now the spreadsheet can provide not only the consequence of
price change but also a comparative-static look at the probability of price
change. The basic matrix now enforces current futures plus or minus two
standard deviations as the upper and lower price bound.
Another improvement has been the addition of Loan Deficiency Payment
estimates as prices rise and fall. While computationally easy to add to
the information, it became essential as crop prices approached and fell
below loan rates. It became quite apparent that producer focus on LDP
levels had to be addressed. An interesting exercise has been to review
the graphs of market strategy response to price changes when LDP’s are
added. I was not taught to expect bowl-shaped strategy results curves
over the relevant range of probable prices when I first studied market
risk management as a student.
Where to from here? Next versions planned will include a post-harvest
set of strategies to address questions like “Should I sell & ‘pop’ now or
store till (month) while I hold out for the larger LDP?” Any comments or
corrections are solicited from those who might want to utilize these
simple spreadsheets.
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