Tariff action and trade tiffs have dominated the Trump administration’s first three months, creating one of the greatest periods of market uncertainty many of us have ever had to manage. It’s true what they say: Markets don’t like uncertainty.
For markets, certainty equals confidence. If participants are confident in the market’s trend, professional trading funds, for example, pile onto one side of the market with high certainty it’s the right decision.
When there’s uncertainty, or low confidence, traders and fund managers are less committed to positions. They are into a new position at the start of a session and out before the closing bell.
In times of uncertainty, it’s best to go back to the basics of risk management. Effective risk management has little room for mistakes, but that doesn’t mean it has to be perfect. It just means you follow the basic rules in selecting the right marketing tool to use at the right time.
Rule #1: Basis Matters
- When basis is above the three-year-average, use marketing strategies that capture that basis strength with a cash sale for immediate or forward delivery. That includes a basis contract that sets basis but leaves price open.
- When basis is below the three-year average, use marketing strategies that leave basis open. Those options range from doing nothing to a short position in futures as a hedge against downside price risk.
Rule #2: Price Matters
- If you anticipate higher futures prices ahead, use strategies that leave price open.
- If you anticipate lower futures prices ahead, use strategies that capture price.
Rule #3: Now Put Basis and Price Together
- When basis is strong and you’re bearish on prices, capture basis and price. That’s a cash sale for immediate delivery. If you don’t have the bushels to move that’s a forward-cash contract for future delivery.
- When basis is strong and you’re bullish on prices, capture basis and leave price open. A basis contract can work great in a scenario like this — so does a minimum price contract with cash sale covered by a long call option. Remember, the premium on a call option generally appreciates as futures prices rise.
- When basis is weak and you’re bearish on prices, capture price but leave basis open. A short futures position against your grain in the bin or in the field captures price. When basis returns to normal or strong levels, make the cash sale and exit the short futures to capture basis. A put option will provide similar protection. The premium on a put option generally appreciates as futures prices fall.
- When basis is weak and you’re bullish on prices, choose a strategy that leaves basis and price open. Simply put: do nothing, but make sure the decision to do nothing is reasonable.
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