At this writing, the Kansas City Board of Trade (KCBT) July 2008 wheat contract price is $6.79. Only two weeks ago, the KCBT July 2008 contract price was $5.77. Short topsoil moisture in parts of the hard red winter wheat area, and drought in parts of the Mississippi Valley area (soft red winter wheat) is limiting planting. Stocks are too tight to lose the 2008 U.S. winter wheat crop.
Some elevators in Oklahoma are offering 53 cents less (-$0.53) than the KCBT July 2008 wheat contract for June 2008 delivered wheat. At this writing, the forward contract price for June 2008 is $6.26.
As many Oklahoma and Kansas producers found during the 2007 wheat harvest and many Texas panhandle producers found during the 2006 wheat harvest, forward contracting has its risk. Sometimes weather limits production. And buying back a forward contract creates a “double whammy.” There is no wheat to deliver or sell, and the cash price is normally higher than the forward contracted price. The contract must be “bought back” at a higher price.
An alternative is to hedge by selling KCBT July 2008 wheat contracts. This too has risk. Producers that hedged by selling the KCBT July 2008 wheat contracts two weeks ago have had to increase their margin accounts by $5,100 per contract ($6.79 - $5.77 = $1.02 x 5,000). A producer hedging 20,000 bushels has had to “pony-up” up $20,400.
The KCBT Dec. 2007 wheat contract price may be used to illustrate how high the KCBT July 2008 wheat contract can go. If 2008 U.S. winter wheat production is not sufficient to meet demand and build stocks, cash and futures contract prices must go to current price levels.
At this writing, Oklahoma cash prices are between $8.44 and $8.56, and Texas Panhandle prices are between $8.37 and $8.51. The KCBT Dec. 2007 wheat contract price is $9.20. If the KCBT July wheat contract price increased to $9.20, the margin call would be $17,150 per contract — ($9.20 - $5.77) x 5,000.
Another strategy is to buy put option contracts or to forward contract and buy call option contracts. “At the money” (strike price nearest July 2008 contract price) put option contracts cost about 60 cents per bushel or $3,000 per contract.
The KBCT July 2008 contract price is $6.89. A $6.90 put option contract premium is about $0.60. The expected minimum price for Oklahoma would be about $5.79. This was calculated using an expected basis of a minus 40 cents ($6.79 - $0.60 - $0.40).
The expected minimum price for the Texas panhandle would be $5.80. The panhandle basis is expected to be about 10 cents less than the Oklahoma basis.
Another method is to forward contract ($6.26) and buy a KCBT July 2008 $6.90 call option contract. The minimum price would be $5.66. The minimum price is higher with the put option contract because the expected June 2008 basis is about 13 cents higher than the current offered forward contract basis (-$0.40 vs. -$0.53).
The choices are to forward contract for $6.26, set an expected $5.79 minimum price by buying a put or setting a $5.66 minimum by forward contract and buying a call. Another choice is to do nothing and take the June 2008 cash price.
June 2008 wheat prices could be between $4.50 and $8.50. Near record 2008 wheat production would result in significantly lower wheat prices. Another wheat crop like the one this past year and wheat prices could be $8.50. The current expected price is $5.25.
Consider this in your decision. If you have a relatively large wheat crop to sell, the price will probably be above $6.26. If you do not have much wheat to sell, the price will probably be above $6.26. Higher and lower prices are often offset by production.
My advice is to keep marketing simple and make decisions that let you sleep at night. If you lay awake worrying about lower prices, price some 2008 wheat. If you will lay awake at night worrying about producing wheat to meet your contracts, don’t do anything.