Disclaimer: This web page is designed to aid farmers with their marketing and risk management decisions. The risk of loss in trading futures, options, forward contracts, and hedge-to-arrive can be substantial and no warranty is given or implied by the author or any other party. Each farmer must consider whether such marketing strategies are appropriate for his or her situation. This web page does not represent the views of Kansas State University. 

Our Bank Strongly Recommends the RA-HPO[1]

I received the following comment on the purchase of the harvest price option from a lender.  Deleting the harvest price option is not a simple decision. 

Dr. Barnaby ,

In the preceding email, you address the enterprise units, but not the writer’s choice of RA-NHPO.

RA-NHPO would be bad deal on soybeans this year, since it looks like the harvest price will be considerably higher than the base price.  Same situation with spring wheat last year.  The bushel coverage goes down as the price goes up.  Should a grower guess which way the market will be in the fall and risk the reduction in coverage to save a dollar in premium?

Also, RA-NHPO doesn't do anything to reduce the delivery risk of forward contracts.  One of the main reasons for having a revenue product is to integrate with your marketing plan to reduce marketing risks.

We strongly recommend the RA-HPO to our producers and if they still want the RA-NHPO we ask them to sign a disclaimer stating that we have explained the limitations of NHPO and they understand those limitations.

Mr. Banker

Dear Mr. Banker

This grower was buying 10% higher coverage under RA-NHPO versus lower coverage under RA-HPO.  Does the higher coverage offset the HPO?  In this case the grower thought it did because his major concern was yield.

If the major risk is yield and the yield is near zero then increasing market prices will have little impact on the indemnity payment.  The market price would have to increase by more than 10% before the RA-HPO would pay more with yields near zero.  The price history for Kansas wheat is also located on the WEB at

http://www.agmanager.info/crops/insurance/workshops/filespdf/kw.pdf

Other Crop harvest price histories are located at:

http://www.agmanager.info/crops/insurance/workshops/default.asp

There were only 10 years out of the last 31 years where the price increased by more than 10%.  So buying RA-NHOP at a 10% higher coverage level would have proved better coverage than RA-HPO in 21 out of 31 years.  Are you sure the answer is as clear as you are suggesting?

I am sure this person was not forward pricing the wheat but simply using the loan and storage to market the crop after harvest.  If he had forward contracted then he probably was taking on more risk by dropping the harvest price option.

However, there is always a tradeoff between coverage and premium.  It will depend on the risk the grower can carry and the risk of greatest concern, in this case drought.

There is a crop insurance simulator located on AgManager.info that provides a more rigorous analysis of this insurance question. The simulator is located at:

http://www.agmanager.info/crops/insurance/spreadsheets/default.asp

Thanks for your comment.  I am sure others have had a similar question.

ART