Published on 02/17/97

Farmers Turning to Insurance Against Price Drops

Radical changes in federal farm programs have led farmers in Georgia and elsewhere to buy a lot more insurance these days. Not on their tractors, or even their crops. They're insuring the prices they get for their crops.

"If you insure a car, you're protecting it against potential damage," said George Shumaker, an economist with the University of Georgia Extension Service.

"A price is 'damaged' if it drops," he said. "When farmers buy options, they're just buying insurance to protect them against a drop in prices."

Agricultural commodity options, he said, are agreements that guarantee the option buyer the right to buy or sell a commodity for a certain price.

A "call" option fixes the maximum price the option holder will have to pay for a crop. A "put" option sets the minimum price he will get for his crop.

In the first year under the new federal farm bill, farmers are buying put options more than ever, Shumaker said. He cites two main factors that figure in the trend.

"First," he said, "farmers no longer have the target price- deficiency payment subsidy system they had under previous farm programs."

Under the old programs, he said, subsidies would kick in if the market price for a crop fell below a certain target price. In effect, the system set a minimum price growers knew they could get for their crops.

"Now, though, their income is dependent on market prices, not on subsidy levels," Shumaker said.

"The second factor," he said, "is the likelihood of greater price fluctuations as a result of the removal of federal supply controls."

Under past farm programs, he said, farmers had to participate in acreage restriction programs to be eligible for subsidy payments. With the new farm bill, though, they're free to plant whatever they want. So the supply of farm commodities is open to much wider fluctuations.

"Before, farmers were buffered by the actions of the federal government," Shumaker said. "Now they will feel the brunt of market price swings.

"As a result, they're seeking ways to protect themselves against a drop in market prices," he said. "Put options give them the ability to manage their price risk."

If farmers weren't convinced of the value of put options before, they probably became believers by the end of 1996.

"They saw corn prices at $5 a bushel in May and June," Shumaker said. "By December the price was down to $2.50 a bushel. And wheat prices went from around $7 a bushel to less than $3."

The trend to greater use of put options is a sound one for Georgia farmers, he said.

"A put option is one of a toolbox full of marketing techniques that can be used," he said. "It should definitely be a part of a farmer's marketing plan."

But it should never be the only part, he said. Among other things, Shumaker urges growers to use:

* Cash forward contracts, which set a fixed price a farmer will get for his crop.

* Basis contracts, which lock in the relationship between local cash markets and futures markets. "These should be used in conjunction with put options, which are based on futures markets," he said.

Dan Rahn is a news editor with the University of Georgia College of Agricultural and Environmental Sciences.