You remember the commodity price boom during Covid, right? I’ll bet you do! You probably celebrated windfall profits during that time.

Those years are in the past though, and  now you’re most likely feeling the sting of low crop prices coupled with increased operating costs. How are you to properly manage the financial side of your operation?

One way many farmers manage their finances is through hedging with futures contracts.

What Does a Futures Contract Represent?

A futures contract is an agreement traded on an organized exchange to buy or sell assets, especially commodities or stock shares, at a fixed price, to be delivered and paid for later.

Commodity futures must be up to certain specifications, such as quality of goods, quantity of goods, physical delivery time, and specific location at delivery.

By utilizing these financial vehicles, you can sell your crops before they’re available.

Why Hedge With Futures?

Commodity prices change by the second, leaving you with a speculative position throughout the year. This uncertainty is a cause of stress for many farmers.

When you plant a crop, it requires a large financial investment from the outset. Yet, the revenue you can count on remains to be seen. A better method from a risk management perspective is to hedge your sale price soon after planting, thus alleviating your concern from the subsequent price fluctuations.

Now that we know the why, let’s discuss the how.

Hedge Step 1: Sell Your Crops

After planting, yet months before harvest, you will short futures contacts equivalent to the expected yield for the season. This is done through the Chicago Mercantile Exchange Group (CME Group). Once the trade is filled, both you and a buyer of the contract(s) have agreed to a transfer of the commodity at a certain date, to a specific location, and at a certain price.

You’ve essentially sold your crop before harvest and can manage your finances more thoroughly throughout the season.

Step 2: Lift the Hedge

When the time comes for you to meet your obligation in the agreement (known as lifting the hedge), it can be completed in one of two ways.

1. You can deliver the product as agreed in the contract
2. Offset your futures hedge position

When you deliver the commodity, you receive the agreed-upon price for your crop, regardless of the current cash price. However, delivering the physical commodity has additional costs involved (shipping, etc.), so you may also move ahead with the second option.

Rather than delivering your crop to the buyer, you can offset your hedge position by purchasing identical contracts to the short position currently held.

Once the hedge position is closed, you no longer have an obligation to deliver the crop to the buyer. When this option is used, the difference between the spot price and the previously agreed-upon price allows you to make a profit or take a loss on the hedge position.

In either case, you’ll be receiving what you expected at the onset of the hedge, thus allowing your financial plan for the year to come to fruition.*

What Does Any of This Have to Do with an Insurance Blog?

At the crux of it, hedging is a risk management tool – just like insurance. Think of using commodity futures in this manner as a form of insurance to protect against fluctuations in your revenue.

As you protect your income with hedging strategies, keep in mind the other areas of your operation that need to be protected.

If you haven’t had a comprehensive review of your farm insurance plan for a while, your coverage may no longer be adequate for your needs. That’s where we come in! Contact us for a detailed audit of your farm insurance before your next renewal to ensure you’re fully prepared for whatever may come next.

*Please note that trading commodity futures contains risk. Discuss with your qualified financial advisor whether the use of these assets is suitable for you and your situation prior to proceeding.

Richey-Barrett Insurance is not involved with the commodity futures markets, and this blog is not meant as a solicitation to buy or sell any futures contracts or any other type of investment products.