Risks of Falling Prices at Harvest on Corn and Soybean Futures
Futures prices at harvest 2021 are above $ 6.00 a bushel for corn and $ 14.00 a bushel for soybeans, well above most prices since 2013. Some farmers express their concerns about falling prices.
Using a web-based farmdoc tool, we were able to arrive at a market-based assessment of potential price drops. This tool indicates a 9% probability that corn prices will fall by more than $ 2.00 per bushel and a 20% probability that soybean prices will fall by more than $ 2.00 per bushel.
Current market conditions indicate higher probabilities of falling prices than historical deviations imply. Still, there are excellent chances of above-average prices this fall, and chances of much higher prices if yields drop.
The price discovery tool on the farmdoc website allows a user to assess the downside risks of Chicago Mercantile Exchange (CME) contracts for corn and soybeans (click here). This release was captured on Monday, May 10, 2021, when the contract price for December 2021 was $ 6.09.
The price discovery tool uses the current levels of futures and options prices to develop price distributions near the expiration of the contract. Well-tested option pricing models are used to develop price distributions. The price possibilities are given in four different formats comprising two graphs and two tables:
- A cumulative probability of prices at expiration (chart in the upper left corner) shows the prices along the horizontal axis and the probability along the vertical axis. For a given price, the probability of being below the price is given on the vertical axis. The edge of the area shaded in blue is the price of $ 6.09. There is a 55% chance that harvest prices will be below $ 6.09. It also means that there is a 45% chance that corn harvest prices will exceed $ 6.09. Higher prices could occur if there is a production shortfall due to a drought.
- The probability of prices at expiration (graph in the lower left corner) shows a probability distribution. This is the standard representation of probabilities.
- The table at the top right shows the prices at expiration and then gives a “probability below”. At expiration, there is a 27.24% probability of being less than $ 5.00 per bushel, a 33.64% probability of being less than $ 5.25, and so on.
- The table at the bottom right reverses the presentation above (given in 3). There is a 5% chance of being below $ 3.79, a 15% chance of being below $ 4.46, and so on.
On May 10, the December 2021 contract price was $ 6.09 per bushel, $ 1.51 more than the projected price of $ 4.58 used to establish crop insurance guarantees. The Price Discovery Tool calculates a 17% probability of being below the expected price. Overall, the tool indicates:
- The probability of a drop of more than $ 0.50 from the current price of $ 6.09 (i.e. a price of $ 5.59 or less) is 43%.
- The probability of a decline greater than $ 1.00 (i.e. less than $ 5.09) is 30%.
- The probability of a decline greater than $ 2.00 (that is, less than $ 4.09) is 9%.
These probabilities are higher than those suggested by historical price changes. Figure 2 shows the annual difference between the average December contract settlement in May minus the average October settlement price. October was chosen for this valuation because that month is used to calculate the price of the crop and settle crop insurance contracts in the Midwest.
- The historical occurrence of a price drop of $ 0.50 or more is 9 years 36 or 25% of the time. The historical occurrence of 25% is lower than the 43% chance of the price discovery model.
- The historical occurrence of a price drop of $ 1.00 or more is 3 years 36 or 8% of the time. The price discovery model suggests a 30% probability of a price drop of $ 1.00 or more.
- The historical occurrence of a price drop of $ 2.00 or more is 1 year in 36 or 3% of the time, compared to a probability of 9% depending on the price discovery model.
The Price Discovery Tool uses option prices to determine price variability, thus providing a market-based assessment of price volatility. This year, option prices are much higher than in recent years, suggesting higher volatility compared to historical averages. For example, the volatilities used to set crop insurance premiums were based on prices for the last five days of February. The volatility of 2021 is 0.23, much higher than the volatility of 0.15 from 2018 to 2020.
Figure 3 shows the November 2021 soybean price discovery tool captured on Monday, May 10, when the futures contract price was $ 14.14. The price discovery tool shows the following:
- The probability of a drop of more than $ 0.50 from the current price of $ 14.14 (i.e. a price of $ 13.64 or less) is 45%.
- The probability of a decline greater than $ 1.00 (i.e. less than $ 13.14) is 30%.
- The probability of a decline greater than $ 2.00 (i.e. less than $ 12.14) is 20%.
- The historical occurrence of a price decline of $ 0.50 or more is 13 out of 36 years, or 39% of the time. The historical occurrence of 39% is lower than the 45% probability of the price discovery model.
- The historical occurrence of a price drop of $ 1.00 or more is 6 out of 36 years, or 17% of the time. The price discovery model suggests a 30% probability of a price drop of $ 1.00 or more.
- The historical occurrence of $ 2.00 per bushel in 2 out of 36 years, or 6% of the time, compared to a 20% probability of the price discovery model.
As with corn, soybean market conditions suggest greater variability than historical occurrences. Crop insurance volatility for 2021 is 0.21, more than all premiums since 2011.
Current market conditions suggest that the downside risks for 2021 are greater than those of recent years. This price discovery tool shows a 9% probability that corn prices will fall by more than $ 2.00 per bushel and a 20% probability that soybean prices will fall by more than $ 2.00 per bushel. Still, the chances of having good prices in 2021 are high. Higher prices are possible if there are yield deficits.
Gary Schnitkey, Krista Swanson and Nick Paulson of the Dept. of Agricultural and Consumer Economics University of Illinois and Carl Zulauf from Dept. of Agricultural, Environmental and Development Economics Ohio State University wrote this article for farmdoc daily.