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Stuck with a $6.50 wheat forward contract

Mar 28, 2008 9:48 AM, By Kim Anderson
Oklahoma State University

Some producers that forward contracted or hedged wheat in the $6.50 range have been trying to figure out how to get out of the contracts. Without gambling $1.30 per bushel or more, there does not appear any way to get a higher price.

When the $6.50 prices were set, the Kansas City Board of Trade (KCBT) wheat contract price was about $7. At this writing, the KCBT July wheat contract price is $11.30. Producers that hedged can buy back the July contracts that they sold at $7 for $11.30. This is a $4.80 per bushel or $2,400 loss for the 5,000-bushel contract.

Producers that forward contracted for $6.50 may be able to buy back the forward contract for $4.30 per bushel plus a transaction fee. The transaction fee would be to reimburse the elevator for brokerage fees and the interest for the $2,400 per contract in margin calls. Fees may be between 30 and 50 cents per bushel.

If these positions were reversed, producers would be better off only if the KCBT July contract price continues to increase. If the July contract price declines, the producers will wish that they had maintained their $6.50 positions.

Another alternative would be to buy at-the-money ($11.30) KCBT July wheat call option contracts. If the July contract price continues to increase, the value of the 1130 call option will increase and the net price for the wheat would increase.

The caveat is that an at-the-money call option costs $1.25 per bushel or $6,250 per 5,000-bushel contract. Buying an 1130 call option would convert the forward contracted or hedged price into a $5.75 minimum price. To net $6.50 for the wheat at harvest, the KCBT July wheat contract price would have to be $12.55 or higher.

There does not appear to be a good way to get out of the forward contract or hedge position. Some people may try to “cheapen” call options by selling put options. This establishes the risk of lower prices to create the opportunity for higher prices.

What these producers can do is to take steps that increase the odds of higher yields. Every bushel that is produced above the contract amount may be sold at the market price at harvest. It may be getting late to apply top dress fertilizer. It is not too late to continually check for insects and diseases and take preventive measures when necessary.

Many wheat farmers are concerned about high prices. Given fertilizer, fuel and other production cost increases, I doubt that wheat prices will be back in the $3 range anytime soon. However, wheat prices could be in the $5 range by the 2009-2010 marketing year.

Farmers can work miracles. High prices, around the world, result in producers increasing planted acres and applying more fertilizer. The result is higher production than consumption, increased stocks, and lower prices.

With normal weather, wheat stocks will increase in both the U.S. and foreign markets. Two good weather years, could result in 2009-2010 U.S. wheat ending stocks being above 500 million bushels, world wheat stocks above 4.8 billion bushels and wheat prices being between $5 and $6.

If weather will cooperate in producing average or better yields in 2008, cash wheat prices are expected to be between $8 and $9 during June, decline below $8 in July and August and be in the $7 range by December 2008.

However, if yields are below average and something happens to a major wheat crop anywhere in the world, wheat prices may be above $12 in December 2008.

Producers have planted the wheat. It is now up to the weather to determine how much wheat is harvested and what the price will be.