Percent Probability

Heather Moffatt, Grain Risk Management Advisor, Agricultural Marketing First

Farmers are known as some of the biggest gamblers in the world. Marketing grain is unique. Only farmers who produce specialty products,
which fit into niche markets, can request their selling price. Many who produce “main stream” commodities are left pricing products that trade on public exchanges widely influenced by speculative participation. Prices are always moving, influenced by fundamental news or
technical analysis. Farmers are gamblers and often place “bets” by weighing out the odds. Sometimes unrealistic price targets are anticipated, with the odds of achieving such goals remote. Other times, high prices seem reasonable given world fundamentals, with the odds of a price decline seeming slim.

Those bets in which the odds are against us are the ones that pay off the most handsomely. I looked to my favorite search engine Google to provide answers to lottery ticket odds. Many of us like to buy our weekly 6/49 or Super 7 lottery tickets. The dream of actually winning millions is a nice thought. Unfortunately according to one Google math whiz, your chances of winning 6/49 are one in 13,983,816. If Super 7 is your lottery of choice you have one chance in 62,891,499 of being able to retire early. One would think the current wheat market rally might fit into the 6/49 category. Prices moved to levels almost unimagined. The hope and anticipation of prices moving to unforeseen levels and the ability to “hit the jackpot” can often misguide the best laid marketing plans.

The Michigan State University Department of Agricultural Economics has an interesting program on their website called Probabilistic Price Forecasts. Access their information at: http://www.msu.edu/user/hilker/. The purpose of their website is to provide individuals with a means by which they may gain some understanding of the uncertainty involved with using futures prices to forecast cash prices. Four professors from the university have devised a mathematical equation using option on futures values to arrive at price probabilities. They feel that option prices reveal information regarding the volatility of cash prices at contract maturity. It’s an interesting perspective which points out short term risk/reward. You can find out more about their theory on the website. One could consider this another tool for your grain marketing “tool box”, not to be used to devise your total marketing plan.

Prices have risen to historically high levels. There is no guarantee they will stay. As input costs move higher, it provides more reason to protect grain futures prices when they rally. Diversify and use put options to provide a floor price. The higher prices rally, the further they have to fall. Don’t gamble with high prices, laying bets that are against the odds. Yes, historically high prices can go higher as evidenced in
the wheat markets’ “perfect storm”. They can also disappoint you, like the corn market this year. If you wanted to play the long shot and lay 100% of your bet on $5.00 corn values, rather than securing $4.00, you’re sorely disappointed this year. The ability of the U.S. farmer to plant a 93 million acre corn crop with a 156 bushel yield (Sept. data) was against all odds this year also. I suspect the volatility we’ve experienced over the last year is not over. Grain prices can move around considerably as we go forward through 2008. Know how to protect prices. Don’t put all of your money on the “long shot” horse.