Creating a Commodity-Rule Based Marking Plan Back »

Written collaboratively by Lisa Elliott and Matthew Elliott.

What is a dynamic commodity rule-based marketing plan? It is a plan that identifies decision points and actions. Each operation should have a unique rule-based marketing plan that reflects production costs, cash flow needs, and insurance coverage. The marketing plan should be aligned with the amount of risk the operation can tolerate. This can be accomplished by identifying the maximum amount of monthly value-at-risk the operation should assume.

The marketing plan should begin when a producer wants to start managing a crop’s value-at-risk. This may start when a producer is beginning to purchase inputs or potentially earlier. However, all plans should start prior to planting. It is best to develop your marketing plan into two components: pre-harvest and post-harvest.

To identify decision points in your marketing plan, you must develop rules. What do we mean by a rule? Rules are based on the following structure: If (condition occurs), then (action occurs).

Rules can be based on various triggers that can include: technical signals, fundamental signals, and/or specific dates.

An example of a technical rule that could be included in a marketing plan would be:

If nearby Corn futures price goes above the Upper Bollinger Band (using a Moving Day Average of 20 days and 2 Standard deviations), then sell/hedge a specified quantity of bushels.

The execution of this rule can be demonstrated in Figure 1. If the above stated rule was executed on September 1, 2018, we would notice that the nearby corn futures price, shown by the orange line in Figure 1, was below the 20-day moving average (blue line) and the Upper Bollinger band line (grey line). According to Figure 1, and the above rule, there would have been a sell signal on September 26, 2018 when the nearby corn futures price crossed above the Upper Bollinger band.

Fundamental rules, like technical rules, can also be used in a marketing plan.

An example of a fundamental rule would be:

If corn stocks-to-use decreases by one percent or more, and subsequently nearby corn prices increase by 10 cents per corn bushel or more, then sell/hedge a specified quantity of bushels.

As of September 27, 2018, U.S. corn stock-to-use is at 11.7%. So, if this fundamental rule was executed as of this time going forward. Then this rule would not be triggered until potentially a new WASDE report release. So, if corn-stock-to-use in the next WASDE report decreased from 11.7% U.S. corn stock-to-use to 10.5%, which then coincided with nearby futures increasing by 13 cents per corn bushel, then a selling trigger would be activated. Then, the producer would need to decide whether to act on this trigger, or whether there is a fundamental reason to ignore the signal.

There are two outcomes that can occur based on the rule 1) When the condition occurs, resulting in the action outlined, or 2) when the condition does not occur.

Figure 1
Figure 1. Nearby Corn Futures with 20-day Moving Average and Upper Bollinger Band.

When the producer develops a rule based marketing plan, it allows for the producer to examine historical conditions to first determine the performance of the rule, and second to see how many triggers that the rules typically produce. This will allow the producer to determine the quantity of bushels to be sold to effectively execute the above stated rule. To determine the performance of the rules relative to alternative rules the producer can back-test the rule using historical data. If the rule condition does not occur or is not expected to occur frequently, then the producer should think of contingency plans or secondary triggers to manage value-at-risk in order to keep value-at-risk at a level the operation can tolerate. This could be done by setting date deadlines where a certain percentage of bushels will be sold if the rules do not trigger. Certain rules can be developed where the rule is only active within a certain period if value-at-risk is at acceptable levels.

The original technical rule also could be altered to a shorter-term perspective, where there is greater likelihood of more conditions to occur. This can be done, for example, by adjusting technical indicator settings like changing the moving day average and/or reducing the number of standard deviations for the Bollinger Band, for example. The effect of changing the technical indicator settings will result in a higher or lower chance of signals that a condition has occurred that requires action. If this secondary rule still does not trigger, then a date deadline trigger could be executed to sell a certain percentage of the crop by the deadline. This deadline could be set based on cash flow needs or other considerations.

To summarize, developing a rule based marketing plans accomplishes two functions.

  1. It allows the marketing plan to be back-tested using historical data to compare the performance against other strategies.
  2. The rule-based marketing plan could be shared with lenders to assist a producer in communicating on how they are managing their operation’s value-at-risk.

By increasing, the transparency on how value-at-risk is being managed can help lenders and farm stakeholders understand the importance of providing lines of credit or capital to meet potential capital requirements when utilizing futures and/or options.

 

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This material is based upon work supported by USDA/NIFA under Award Number 2015-49200-24226.

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