Chapter 14 - Marketing

Marketing

Growers make several marketing decisions in the spring, one of which is what they will plant. While this decision is based partly on market signals, other factors enter into the "what to seed" decision, such as crop rotation, climatic conditions and experience with a crop. Growers can affect their bottom lines by focusing on production management that maximizes productivity or by reducing per unit costs. Production and marketing are a partnership to improve grower returns. Successful marketing depends on a good plan. It takes into account the financial requirement of the farm and the options available to meet those requirements.

Background

Canola is an "open market" or "non-board" commodity. Consequently, the canola grower "sells direct" to the canola buyer.

Compared to many commodities produced in Canada, which are largely dependent on export markets, canola demand is more evenly distributed between domestic and export markets. Excluding seed retained for seed and feed, between 40 and 45% of canola is used domestically and the remainder exported. This dual market, coupled with open market selling, provides growers with several marketing alternatives and options within those alternatives.

In the open market system, growers receive the price of canola on the day they sell or price their canola. Price is a function of supply and demand, therefore it fluctuates accordingly. The decision on when best to market canola will depend on several parameters:

• financial position
• cash flow requirements
• price
• transportation
• storage facilities
• weather

The decision on where to market canola will be influenced by:

• delivery opportunities
• pricing and contracting options
• service
• price

The following delivery alternatives are available.

Country Elevator

The local elevator is the collection point for a grain handling company. In most cases, the canola purchased from growers is resold to the end user. (It may also be sold to a broker or exporting company, which has no country collection system.) The grain company purchases canola in order to fill sales which it already has made, or anticipates making, in the export market. Some country elevators may also act as off-site collection and storage points for canola crushers.

Crushing Plant

Canola seed is crushed primarily for its edible vegetable oil content. Canola meal for livestock feed is a by-product of crushing. A regular supply of canola is required to maintain ongoing operations at the plants. While constant operation is preferable (except for periods of plant maintenance), some of the plants have closed for extended periods when faced with negative crush margins. Roughly 45% of the oil and 60% of the meal produced by the Canadian crushing industry must find a home in the export market.

Producer Car

Growers can choose to load their own railway cars, bypassing the country elevator system. Growers must apply to the Canadian Grain Commission for producer cars.

Grain Dealers

Grain dealers are essentially grain/canola marketers or brokers. They may not have an extensive infrastructure for gathering grain or oilseeds nor do they usually make sales directly into foreign markets. They arrange for a sale to an exporter in Vancouver, purchase canola from growers, and are then allocated rail cars, called dealer cars, to ship the canola to Vancouver to meet their sales commitments.

Futures Market

If financially beneficial, growers may decide to use the futures market to "lock in" a price and liquidate the futures contract position when they deliver the canola in the cash market. Farmers may also deliver against a futures position via a third-party agreement with a merchant participant. For more information contact the Winnipeg Commodity Exchange Inc. (WCE) Web site at www.wce.ca or by calling (204) 925-5000.

When making a marketing decision, weigh the advantages and disadvantages of various options and strike a balance that achieves the goals. Remember, what appears to be advantageous one year may not be the next. Consider all the options in light of current circumstances.

The degree to which growers market their crop will depend on their level of interest, capabilities, time demands, and their risk aversion. Some choose to do minimal marketing, preferring to sell to the local elevator for a set price when cash is required. Due to time demands, growers may appreciate the full line of services offered by the country elevator. It may be worth the time to reduce downside price risk by hedging the crop through the futures market. If growers feel they need a guaranteed market for a percentage of their crop, they can enter into a production contract with a canola crusher. It may be more efficient to load producer cars and assign the savings against time and labour. One may use a combination of any or all of the above in order to take advantage of the benefits offered by each.

Growers may decide to average their returns, in effect creating a pooled price, by selling at regular intervals during the year. Price is often the determining factor in whether to sell. However, growers who practice effective marketing need to look past the apparent price and consider:

• What does the price include (for example, is there service attached to it and can growers make use of the service)?
• What is the cost of not accepting the price (for example, consider the carrying costs, such as storage and interest associated with the particular option)?
• What are the chances for future price movement-either for or against?
• Does the price provide an acceptable level of return?

In developing a marketing strategy, take two key factors into consideration (because they will have a bearing on when and how to sell canola)-cash flow requirements and cost of production. The timing of cash injections into the operation will help determine during what periods of the year to sell canola. The cost of production (fixed and variable costs) will provide a guideline as to what is an acceptable selling price. The market has as much tendency to go down as up, so determine what price is required to cover costs. Hoping for a certain price (speculating) won't cover expenses. Know what is a realistic expectation and what is purely speculation.

Building Blocks to a Marketing Strategy

Price Determination

Under most circumstances, the primary consideration in a decision to hold or sell canola will be price. In order to develop a marketing strategy, be aware of the factors that enter into price determination. While the price for oilseeds is established internationally, there are domestic influences that also contribute to the final price.

Price is a result of the interaction of supply and demand. Basic economics say that as long as there is no interference with market forces, demand in excess of supply will drive prices up, stimulating more production. Conversely, supply in excess of demand drives prices down, causing decreased production and the possibility of increased demand. Where there is no market interference or artificial barrier, supply and demand always try to seek a balance or equilibrium point. Supply and demand situations can change from day to day, month to month and year to year. For example:

• An exporter makes a sale, which requires seed from the country; demand at the company's country points increases.
• The supply is higher in September/October when the crop is harvested than in July.
• As world population increases, demand for vegetable oil increases from year to year.

One other fact to consider related to supply and demand is price elasticity. Price elasticity is an indicator of what will happen to sales as prices move up or down. For example, wheat is relatively price inelastic compared to canola. As there is a limit to the amount of wheat humans can or will consume, a decrease in price will not necessarily stimulate increased demand. However, in the case of vegetable oil, because it is used as a source of food and as a cooking medium, decreased prices will increase demand. People become less conscious of conserving their frying and cooking oils, and consequently use more. In a declining market growers are relatively better off with a price elastic commodity than one that is price inelastic.

When considering the supply side of the picture it is important to keep in mind not just the current year's production but also carryover or carry-in stocks. These are stocks of canola from the previous year's production that have not yet been used. Canadian carryover stocks consist of canola on hand at the end of the year, either on farms or in commercial channels that had not yet been crushed or exported. World carryover stocks consist of all commercial and farm stocks held anywhere in the world. (The level of carryover stocks is a measure of how tight or loose is the supply/demand balance.) For example, if carryover stocks are high, buyers will bid less aggressively because they know there are ample stocks; sellers will be more willing to sell (within limits) and prices will decline.

While carryover stocks are a good indicator of price trends from year to year, they are not that helpful over a longer time period. This is because carryover stocks alone give no indication of changing consumption patterns over time. A more effective indicator is the stocks:use ratio. It's a measure of the canola carryover as a per cent of annual canola usage. The ratio allows for changes in usage. For example, a carryover of 600,000 tonnes (t) in 1977-78 would have been quite burdensome with a stocks:use ratio of 36%. In 2000-01, that same tonnage would be considered tight with a stocks:use ratio of 15%. Therefore, a useful way to measure supply/demand trends, and gain an indication of future prices, is to calculate the stocks:use ratio for the current year and compare it to historical ratios (Table 1).

Table 1. Canadian Supply and Demand - August/July Crop Year (000 tonnes)

	95/96	96/97	97/98	98/99	99/00	00/01	01/02
Beginning Stocks	589	1,030	563	363	633	2,157	1,088
Production	6,436	5,062	6,393	7,643	8,798	7,205	4,926
Imports	97	103	141	158	124	225	226
Total Supply	7,122	6,196	7,096	8,164	9,555	9,587	6,240
Exports	2,804	2,519	2,964	3,900	3,885	4,859	2,524
Domestic Crush	2,753	2,712	3,239	3,062	2,983	3,013	2,293
Seed, Feed and Waste	641	363	490	569	581	627	208
Total Demand	6,198	5,594	6,693	7,531	7,449	8,499	5,025
Ending Stocks	990	563	361	633	2,106	1,088	1,215
Stocks/Use	16.0	10.1	5.4	8.2	9.6	9.6	6.2

Source: Statistics Canada, Canola Council of Canada
Totals may not add due to rounding

Futures, Cash and Street Prices

How can canola growers follow price movement to determine the timing of canola sales?

Most growers will be familiar with grain and oilseed market or price reports, which are broadcast daily or listed in farm publications weekly. Most growers are familiar with the three market price terms futures, cash and street. There is often confusion between the terms cash and street price, and sometimes there is uncertainty as to how the futures price is established and its relationship to the cash and street price.

The futures price is determined through a bid system at a public commodity exchange. In its most simplistic sense, the futures market allows buyers and sellers to come together to publicly discover what one is willing to commit to pay for a commodity and what the other is willing to commit to sell it for at some time in the future. Typically, prices rise if domestic and/or international indicators suggest there will be a shortage or improved demand, and prices will fall if oversupply or decreased demand is expected.

The cash price is the price paid for immediate delivery at a given location (spot oilseeds). Most cash prices are quoted for oilseeds at a terminal position (for example, Vancouver). In a perfect market, cash and futures prices differ by the cost of carrying the canola from the present to the future month. However, because perfect markets are rare, cash prices could be at a discount or premium to the futures price, depending on the supply and demand at the current time at the terminal location. In a perfect market situation, the cash price will be equal to the futures price during the delivery month (adjusted for quality and location differences).

The street price is the price received at the local elevator, crushing plant, or from the grain dealer. Street and futures prices are related. The spread (or difference) between them is referred to as the basis, and reflects the difference in value of a cash deal versus a deal to fulfill the terms and conditions of the futures contract. It includes such costs as elevation, freight, cleaning, storage, quality, storage requirements and opportunity costs of an elevator's storage bins.

International Factors

The world oilseed market is very complex. Oil World, a German publication, which is the bible for those in the edible oil trade, lists 12 commodities as the major sources of edible oils and fats in the world (Table 2).

Table 2. World Production, Major Vegetable and Marine Oils (million tonnes)

	96/97	97/98	98/99	99/00	00/01	01/02f
Soybeans	20.9	23.2	24.6	25.3	27.1	29.2
Palm	17.6	17.1	19.4	21.2	23.5	23.8
Sunflower Seed	9.1	8.4	9.3	9.5	8.7	7.7
Canola/Rapeseed	11.5	12.2	12.7	14.5	14.0	13.6
Cottonseed	4.1	4.1	3.9	3.9	3.9	4.3
Peanut	4.6	4.3	4.8	4.5	4.8	5.5
Coconut	3.1	3.4	2.4	3.0	3.5	3.3
Olive	2.8	2.6	2.5	2.4	2.7	2.8
Corn	1.8	1.9	1.9	2.0	1.9	2.0
Fish	1.3	0.8	1.3	1.5	1.2	1.0
Total	76.8	78.0	82.8	87.8	91.3	93.2

Source: Oil World Annual 2002
Totals may not add due to rounding f = forecast

Price levels for oilseeds are determined by the world demand for their two products, oil and meal. Taking into account quality differences, the various oils or meals must remain price competitive with each other. The relative price of any one oilseed will depend on the availability of, and demand for, its oil or meal. However, if the price gets too far out of line, substitution will occur and bring prices back into line.

Production and export subsidies have often significantly altered supply patterns in the international marketplace and can be one of the leading contributors to depressed prices.

Palm production has radically altered the price structure for vegetable oils. Production management changes have put palm oil onto the world market not only at a low price, but in increased volumes. In the early 1980's, pollinating insects were introduced to the palm plantations, which increased yields substantially. Prior to this period, high volumes of palm oil entered the marketplace at irregular intervals, depending on precipitation levels. With improved pollination, yield levels now move in a two-year cyclical pattern. After a year of high yields, as a result of increased pollination, the palm trees enter a year of semi-dormancy and reduced yields. Not all trees are on the same cycle so production is not that variable.

Palm is not a high protein, meal-producing commodity. So not only does it depress prices through increased volumes, it also can cause problems for oilseed crushers by changing the revenue contributions from the oil vs. protein meal.

Canola prices tend to follow soybean prices because of the dominant position of soybeans in the world oilseed market. Soybeans account for about half of world oilseed production. However, the price relationship between soybeans and canola will depend on the relative values of oil and meal. In many years, world oilseed crushers crush to meet meal demand. Consequently, oilseeds with a high meal content, like soybeans, are preferred and canola values will be pressured. In years when there is a contraction of world livestock numbers, meal demand decreases and high oil-bearing seeds like canola are preferred. As a result, canola would trade at a relative premium to soybeans. Therefore, when watching markets, look at the relative change in livestock numbers, as well as any developments in animal feeds that would displace oilseed meal protein.

While the overall price level may be trending up or down for the crop year and the immediate future, occurrences during the year can cause price rallies and declines independent of the overall trend.

Rallies will occur if there is an indication or belief that anticipated production levels of an oilseed crop will not be reached. Declines can occur when harvested crops enter the market or production appears to be more than anticipated. Prices react to news, founded or unfounded.

As the U.S. soybean crop is a predominant contributor to world oilseed supplies, any news about the crop will affect world soybean and canola prices. The U.S. soybean crop year is from September to August. The United States Department of Agriculture (USDA) regularly releases crop, stocks and supply demand estimates. The markets will react to these reports if the news is different than expected. For example, if the trade, through market intelligence, estimates that growers intend to seed 58 million acres, but the USDA planting intentions report indicates growers anticipate only 56 million acres, prices will rally for the period immediately after the report until other factors, such as weather, start to affect the outlook.

Early in the U.S. crop year, from September to about January, the market tends to concentrate on the final size of the crop just being harvested and the demand prospects. As the crop year advances, traders begin to be increasingly concerned about the size of the upcoming crop. Early in the crop year the market is concerned about the size of the carryover stocks following July 31. From January on, the market concentrates on both carryover stocks in August of the same year and one year later.

Throughout the growing season weather is an important consideration in price movement. The term "weather" market means prices are reacting to changes in weather. Early in the growing season if conditions are dry around seeding, prices may strengthen in anticipation of lower than expected production. If a generalized rain occurs, prices fall.

In addition to the American soybean situation, there is another factor which impacts soybean and canola prices- the South American (SA) soybean crop. SA produces approximately the same amount of beans as the U.S. The SA crop is harvested in the February/March period, and is in effect a second harvest. Consequently, the size and condition of the harvest will impact prices in the late winter. Further, because of the need for foreign exchange, SA suppliers price their beans to sell. They work toward having all their beans sold by September to avoid competing with the U.S. harvest. In effect, this leaves the U.S. as a residual supplier to the world. Increases in SA production take market share from the U.S., impact prices during the period of the crop's marketing, and add to world inventories by the amount of displaced U.S. exports.

A number of other factors contribute to price movement and price trends, which are more difficult to monitor for those who are not regular followers of world economics. World economic conditions impact prices. The relative wellbeing of importing nations impacts demand. Relative values of currencies could increase or decrease the demand for a certain oilseed or its products and shift demand to substitutes. Alternatively, currency movement could make other countries competitive in the traditional market of another country. For example, if the American dollar strengthens in comparison to the Japanese Yen and Canadian dollar, American soybeans become more expensive for the Japanese. The Japanese tendency in such a situation is to increase canola purchases.

Domestic Factors

While the world marketplace sets the general price trend, and international conditions during the growing season will cause temporary fluctuations, factors specific to Canada will affect the price of canola on a day-to-day basis.

As there is a domestic crushing industry in Canada, and because canola is the dominant oil used in this country, canola prices do not necessarily follow a fixed price ratio to soybeans. If Canadian canola supplies are tight there will be a tendency for canola to trade at a premium to soybeans and soybean products.

Localized situations will also affect the price growers receive for their canola. For example, growers may find that one elevator company is offering a lower or higher price relative to the others. If the price is higher, the company is trying to attract canola because it has a buyer. It can afford to increase its price (by narrowing the basis) because it has a sale arranged and consequently has a lower carrying cost. If a company has ample supplies of canola in store and anticipates it will have to carry that canola for a period of time before it can be sold, it will widen its basis to cover this cost.

If supplies are tight, the basis narrows as companies compete to purchase canola to fulfil their market commitments. When supplies are ample, the basis widens. This can occur, in particular, at harvest time when there is substantial canola available. As commercial channels fill, the basis widens to discourage further deliveries until the product can be exported or processed.

The basis may tend to narrow in periods of low prices because growers become reluctant sellers. They become willing to carry their canola in expectation of improved prices. To attract canola supplies, companies with sales commitments offer the growers more by narrowing the basis. As well, the cost of carrying company-held canola is less as prices decline, so this will affect the basis.

Market Analysis

To make marketing decisions, make some predictions about future canola prices. The price outlook for various grains and oilseeds is important when making seeding decisions. Expectations of future price levels will influence the timing of grower sales. If prices are expected to go down, price immediately. If prices are expected to rise, hold off selling until later, as long as the anticipated price increase will cover the carrying costs of holding the grain.

The task of market analysis is to predict price levels in the future. Price prediction involves three components:

• direction (up or down) of the price move
• timing (when)
• magnitude (how much)

No method has ever been developed which can be used to forecast grain prices with perfect certainty. Some methods are more reliable than others.

Market analysts use two general methods of price forecasting, fundamental analysis and technical analysis.

Fundamental Analysis

Fundamental analysis is the assessment of all the known supply/demand factors to determine the expected level of prices to prevail in the future.

For example, if the stocks:use ratio is at a historic high for a given commodity, the futures price for that commodity will be depressed. The decision may be not to plant that crop.

However, if the crop is in hand or in the ground, there are other fundamental indicators to watch when determining when to market or price the crop. September to November, harvest months for Canadian canola and U.S. beans, usually bring abundant supplies and a strain on handling and transportation facilities. Historically, prices are lower at harvest than later in the year. The decision may be not to sell at harvest time.

The USDA releases U.S. planting intentions at the end of March. If the report indicates planting will be significantly lower than the trade anticipated, the market will rally. But if the overall world supply of oilseeds is burdensome, this is a temporary market move and the decision may be to take advantage and forward price or sell during the rally.

These are just a couple of examples of how, by keeping an eye on changing world conditions, to determine the appropriate time to sell or price canola to best advantage.

Technical Analysis

Technical analysis is a more complicated form of market analysis, which takes a fair bit of commitment because it requires regular records of prices. One form of technical analysis is often referred to as charting. It is the study of past price behaviour in an attempt to forecast where prices will go in the future.

A set of price charts provides a record of past prices and an historical perspective on the market. Price charts can be made for a range of commodities both in Canada and the U.S. Charts can also be made for a specific futures contract month, or the nearest futures month throughout the year. Charts can be made for street price, comparing it to the nearby and more distant futures months to get a feel for basis changes.

When charting futures contracts, the most common chart is the bar chart, which records either the weekly or daily high, low, open and close. After charting several prices, price trends and volatility in the market can be identified. It is important to develop a sense of historical perspective as a means to understand why market moves occurred. Without such a perspective, charts can be misleading.

The grower may want to plot the moving average for a price in order to assess trends. It is constructed by adding the new day's price and dropping the first price in the average. Any number of days may be used in calculating the average. Along with the moving average, the daily price is plotted on the chart. Because the moving average includes prices for previous days, it will lag behind the actual change in price. If the price line cuts across the moving average line, it is a signal that the price direction is changing. For example, in an up-trending market both the price and moving average are going up. If the market reverses direction, the price will drop faster than the moving average. While not foolproof, moving averages may signal a top or bottom in a market, which may be in an up or down trend.

Charting volume and open interest also provides clues to market direction in the futures market. Volume is the amount of trading that took place in a given day and is measured in terms of contracts traded. Open interest is the number of contracts outstanding (for example, not offset or delivered against) at the end of the day.

Some general guidelines with respect to volume and open interest are:

Up-Trending (Bull) Market

• If volume and open interest are both up, and prices are up, the market is considered strong.
• If both volume and open interest are down, but prices are higher, the up trend is considered weak.

Down-Trending (Bear) Market

• If volume and open interest are up, but prices are down, the down trend is considered strong.
• If volume and open interest are down and prices are down, the down trend in the market is considered weak. In this circumstance a large amount of contract liquidation will have occurred, and the remaining contract holders are not selling in large volume in anticipation of a market turnaround.

When developing analysis methods keep in mind that technical analysis is not a replacement for fundamental analysis but rather a supplement. When gathering information for either method of analysis, check with professionals who work in the field.

Another factor can affect the market. Sometimes prices appear to move independently of what the fundamental or technical analysis indicates. In these cases the market is being influenced by the behaviour of those who are participating in the market. If, for example, a mood of optimism sweeps buyers, prices will increase for no apparent reason. It is important to be aware that there can be psychological factors that affect the market to avoid being carried away with undue optimism or pessimism.

Strategy Review

The above should give growers a reasonable idea of some of the things they need to keep in mind as they plan their marketing strategies. They need to be aware of international and domestic market conditions. They should now be able to identify factors that affect prices from year to year, as well as during the year. Here's a review of some of the factors to keep in mind.

Year to Year

• stocks:use ratio and carryover stocks
• contraction/expansion of livestock numbers
• currency exchange situations between exporting and importing nations and among exporting nations
• palm production cycle
• trends, which may indicate shifts in production or consumption of any one oilseed
• policies of foreign governments concerning subsidies

During the Year

• weather conditions in the major oilseed growing areas-in particular the U.S. soybean belt
• timing of USDA and Statistics Canada crop, stocks and supply/demand reports
• basis levels
• timing of world harvests, U.S. soybeans, South American soybeans and Canadian canola

The degree to apply this information is applied will depend on personal interest in marketing and the marketing options that best suit farm operations. The amount of information needed to make an informed decision may appear overwhelming. However, do need not feel it is necessary to gather and keep track of all the details. There are knowledgeable sources of information within the industry that can and should be used.

Most provincial departments of agriculture have market analysts who specialize in oilseeds and/or grains. Statistics Canada has statisticians who follow domestic and international markets related to oilseeds. Agricultural economics departments of universities will also have one or more professors who follow markets. Commodity brokers, oilseed crushing companies and grain handling companies should be able to supply market information. Growers who are experienced in marketing or use a number of marketing options are also good sources of information. Check with these sources for their magazine, newsletter and Web site or e-mail recommendations that help in analyzing the market. Ensure a good cross-section of contacts. Analyze the responses from contacts to fit the pieces together to form a foundation for a marketing plan.

Now a look at the mechanics, which allow growers to put their fundamental and technical analyses to work. Tables 1 to 5 provide an overview of the world production of oilseeds and the supply and demand for Canadian canola.

Table 3. World Production of Canola and Rapeseed (million tonnes)

	00/01	01/02	02/03f
European Union (15 countries)	8.96	9.52	9.26
Central Europe	2.23	2.23	2.23
Russia	0.11	0.12	0.11
Ukraine	0.18	0.12	0.10
Canada	7.13	7.01	3.20
U.S.A.	0.92	0.70	0.72
China, PR	11.38	10.14	10.40
India	3.75p	4.66	3.80
Australia	1.78	1.69	0.65
Other countries	1.00	0.97	1.11
World	37.44	37.17	31.57

Source: Oil World Weekly Nov. 15, 2002
Totals may not add due to rounding
p = preliminary f = forecast

Table 4. World Production of Oilseeds (million tonnes)

	97/98	98/99	99/00	00/01	01/02p	02/03f
Soybeans	158.46	160.59	160.18	175.26	183.40	188.46
Cottonseed	34.52	32.83	33.57	33.98	36.93	33.90
Peanuts	20.10	21.99	21.31	22.86	24.35	22.30
Sunflower Seed	23.45	27.40	26.85	23.11	21.50	23.46
Canola/Rapeseed	33.11	36.13	42.62	37.44	36.53	31.57
Sesame Seed	2.67	2.64	2.71	2.96	2.81	2.83
Palm Kernels	4.80	5.80	6.14	6.53	6.62	6.90
Copra	5.08	3.87	5.17	5.60	5.16	4.92
Linseed	2.37	2.83	2.89	2.34	2.15	2.22
Castor Seed	1.16	1.16	1.27	1.33	1.01	0.98
Total	258.72	295.24	302.71	311.40	320.46	317.53

Source: Oil World Weekly, Nov. 15, 2002
Totals may not add due to rounding p = preliminary F = forecast
Crops harvested in the Northern Hemisphere during the latter part of the first year are generally combined
with those harvested in the Southern Hemisphere during the crop year October to September 30

Table 5. World Production of Major High Protein Meals (million tonnes)

	97/98	98/99	99/00	00/01	01/02f
Soybeans	100.8	106.2	109.6	117.5	126.8
Cotton	15.5	14.9	14.7	14.9	16.0
Peanut	6.1	6.9	6.4	6.8	7.8
Sunflower	10.1	11.0	10.9	10.0	8.9
Canola/Rapeseed	18.9	19.5	22.2	21.3	20.5
Sesame	0.9	0.9	0.9	0.9	0.9
Corn Germ	3.0	3.0	3.1	3.0	3.0
Corn Gluten	13.8	14.0	14.6	14.2	14.5
Palm Kernel	2.7	3.0	3.2	3.4	3.5
Copra	1.9	1.3	1.7	2.0	1.8
Linseed	1.3	1.4	1.4	1.3	1.2
Fish	5.2	6.2	7.3	6.7	6.3
Total	180.2	188.3	196.0	202.0	211.2

Source: Oil World Annual 2002
f = forecast
Totals may not add due to rounding

Crops harvested in the Northern Hemisphere during the latter part of the first year are generally combined with those harvested in the Southern Hemisphere during the crop year October to September 30.

The Mechanics of Marketing

Using the Futures Market

To understand how the futures market can be applied to each particular situation, it's important to have a basic understanding of what the futures market is and how it works.

Put simply, the futures market allows for public price discovery. In other words, the price someone is willing to pay for a quantity of canola at a given time, and the price someone is willing to sell that same quantity of canola for. This price is arrived at in public through an open bidding system. The bidding takes place daily during the week on the floor of the Winnipeg Commodity Exchange (WCE) in Winnipeg, MB.

The WCE does not buy or sell canola nor does it influence or set the price. Rather, it acts as a forum where buyers and sellers of canola, through their brokers, can meet to exchange or "trade" set amounts (contracts) of canola for some future period known as the delivery month.

While the basic concept of a futures market may be simply public or open price discovery, its application at the farm level is not well understood by most growers. It is important to take the time to understand how it works. However, before attempting to use the futures market, talk to a variety of people who use futures as part of their business practice. This would include not only brokers but growers experienced in using the futures market.

Hedgers and speculators are the two types of participants in futures trading. A hedger is someone who has an interest in selling or buying the actual commodity. A seller is interested in pre-pricing canola that the seller will have for sale in the future in order to avoid a price decline. A buyer is interested in pre-pricing canola that the buyer will need at some time in the future to avoid a price increase. A speculator has no interest in the actual canola. A speculator is interested solely in profiting from the price movement.

Speculators add liquidity to what otherwise could be a thin market. This means that, without the activities of speculators buying and selling contracts, there may not be enough actual buyers or sellers of canola on a given day to conduct trades for those who want to hedge.

From time to time there is concern that speculators will control market prices. However, this should not be the case as long as there is a workable delivery system. If speculators bid the futures price of a commodity too high in relation to the actual market conditions, those who have the commodity for sale would sell futures contracts at the inflated price and actually deliver against the contract when the delivery month arrived. The speculator would then be forced to take delivery of the commodity and sell it at actual market price, which would be under what the speculator had to pay for the futures contract. The speculator could also try to sell the contract. But the speculator would most likely not find a buyer at the inflated price and would take a loss.

If a speculator attempts to drive the price down too far in relation to the actual market conditions, a canola user would buy the futures contract and request delivery in the delivery month. To deliver, the speculator would have to buy canola in the cash market for more than the speculator sold the contract. The speculator could also attempt to buy back the contract to avoid delivery. However, it is unlikely the speculator would find a seller at the depressed price, so the speculator would lose money.

In theory, the threat of delivery or the threat of demanding delivery prevents speculators from controlling the market. The threat of delivery ensures that there is an orderly relationship between the cash and futures market.

Hedging

A hedge is a method of decreasing the risk of holding a cash position (the actual commodity) by taking an offsetting position in the commodity or futures market.

A hedge will protect the owner of canola against downward price movement. However, it will not allow the owner to take advantage of upward price movement. Therefore, before hedging, consider the likelihood of prices moving up or down during the life of the futures contract. If, for example, the market has more potential to decline than go up, the owner may decide to hedge. Hedging is like "locking in" a price.

A hedge is the sale of a futures contract, with the intention to sell canola into the cash market prior to the delivery month and buy back a futures contract in the same amount previously sold or under extreme conditions possibly pursue delivery.

To validate the trade, a portion of the value of the contract must be deposited with the broker's brokerage house. Usually it amounts to 4% or less of the total contract value. This is called margin. The brokerage house must post margin security with the clearinghouse to cover the position of its clients.

To determine whether the futures price is acceptable, know costs of production, costs of storing canola until delivered, costs of interest on stored canola, and the cost of the interest on margin money.

A grower may decide to commit only part of the crop to one futures price. So the grower may decide to hedge only a part of the crop at any one time. This would be particularly important in the situation when hedging early in the season before the crop is harvested, and the grower is not yet certain of the total quantity of canola produced.

The following (Table 6) is an example of a perfect hedge in a declining market. On July 1, a grower decides the price of canola meets the set parameters. The street price is $310. The grower thinks that the price may drop. However, because the crop is not harvested the grower can't sell the canola. The basis, the spread between the current street price and the post-harvest futures, is $35. The grower locks in a price by selling a November contract for $345. By the time the grower has the canola harvested and ready for delivery, on October 1 the market has declined by $10. The grower sells the canola to the local elevator for $300/t and buys a November contract at $335. In terms of net return, the decline in the cash market is offset by the gain in the futures, and the grower has locked in a price of $310.

Table 6. Perfect Hedge in a Declining Market

Date	Futures Transaction	Cash Transaction	Street Price	Basis
July 1	Sell $345		$310	Expected basis $35
Oct. 1	Buy $335	Sell $300	$300	Actual $35
	Gain $10		Down $10	Gain/loss on basis = $0
Net Return = Gain on futures + return from cash $310 = $10 + $300

Assume in the second example (Table 7) that all the circumstances are the same except the grower is wrong and instead of the price declining, it goes up. The grower still has managed to lock in $310. The grower lost $10 on the futures market but the street price rose $10.

Table 7. Perfect Hedge in a Rising Market

Date	Futures Transaction	Cash Transaction	Street Price	Basis
July 1	Sell $345		$310	Expected basis $35
Oct. 1	Buy $355	Sell $320	$320	Actual $35
	Loss $10		Up $10	Gain/loss on basis = $0
Net Return = Loss on futures + return from cash $310 = (-10) + $320

The key concept to understand about hedging is do not sell a contract that is larger than the amount of canola owned (cash position). When delivering canola, the grower must sell an amount equal to the future position held, and must immediately buy back the contract. In other words, the cash and futures positions must always balance. They must be equal and opposite. Do not be concerned with the amount of movement in the market because when hedged, a loss in the futures means an increase in the cash and vice versa, resulting in no net change in financial position.

Taking a position in the market that is out of balance is speculating. When speculating, price movement will put the grower in a potential loss or gain position. As long as the grower has not closed out his/her position (not bought back his/her contract), the grower has an obligation to deliver canola in the amount of the short contract during the delivery month. Buying back the contract cancels the obligation to deliver. Another way to view hedging is that it provides the grower with a floor price, but it does not let the grower take advantage of a rise in the market.

At times growers will find that market prices are moving rapidly. This would be of particular concern to a hedger trying to buy back a contract in a fast moving up-trending market. In a fast up-trending market, growers can protect themselves by buying back their futures contracts before they sell cash canola.

Once the futures contract is bought back, the grower can sell the canola. As a seller, the grower can ride out the up trend or sell now accepting whatever gains have been made. The third example (Table 8) shows what would happen if cash canola was sold on October 1 but the futures contract wasn't bought back till October 5, by which time prices had increased $40/t.

Table 8. Up-trending Market - Cash Grain is Sold before Futures Contract is Bought Back

Date	Futures Transaction	Cash Transaction	Street Price	Basis
July 1	Sell $345		$310	Expected $35
Oct. 1	Buy $360 Futures not liquidated	Sell $325	$325	Basis if futures liquidate at time of cash sale - $35
Oct. 5	Buy $400
	Loss $55	Gain $10	Up $15	Gain/loss on basis = $0
Net Return = Loss on futures + return from cash $270 = (-$55) + $325 of which $40/t was a speculative loss

Conversely, in a fast moving down-trending market, the grower need not be as concerned because if the grower doesn't buy back the contracts he/she stands to gain (Table 9). However, the speculative nature of such a decision should be clearly understood.

Table 9. Down-trending Market - Cash Grain is Sold before Contract is Bought Back

Date	Futures Transaction	Cash Transaction	Street Price	Basis
July 1	Sell $345		$310	Expected $35
Oct. 1	Buy $325 Futures not liquidated	Sell $290	$290	Basis if hedge liquidated - $35
Oct. 5	Buy $305
	Loss $40	Gain $10	Decline $20	Gain/loss on basis = $0
Net Return = Gain on futures + return from cash $330 = $40 + $290 of which $20/t was a speculative gain

Further, a hedge is not an elimination of risk, it is a reduction of risk. What was discussed in the previous examples was a perfect hedge. However, hedges are rarely perfect because not only can there be price movement but also basis movement. Usually changes in basis are smaller and more gradual than changes in prices. Also, basis level changes tend to be more predictable. Factors affecting basis are local, such as:

• growers' price expectations
• local supplies vs. grain company needs
• elevator space availability
• crusher demand
• transportation

On the other hand, factors that affect price levels are usually foreign such as grain embargoes, crop failure or other factors for which the grower has less access to information. Once hedged, the grower has eliminated a large portion of the price level risk but is still open to basis risk. Consider the following example (Table 10). On July 1 the street price was $315. November futures were $350. By October 1, the cash price had dropped to $300. The basis had also widened from $35 to $40. The grower received $5 less than anticipated (or $310) because the basis moved against him (widened).

Table 10. Effect of a Basis Change on a Hedge

Date	Futures Transaction	Cash Transaction	Street Price	Basis
July 1	Sell $350		$315	Expected $35
Oct. 1	$340	Sell $300	$300	Actual $40
	Gain $10		Decline $15	Loss on basis = $5
Net Return = Gain on futures + return from cash $310 = $10 + $300

The Mechanics of Trading

Growers cannot directly enter into a trade on the WCE unless they are registered as a Trade Participant. Alternatively, trading can be done through someone who has an agreement with the WCE. This person is known as a broker. To work with a broker the grower must open an account with a brokerage firm (Futures Commission Merchant). Opening an account involves establishing financial credibility and depositing enough money to cover a percentage of the value of the contracts (margin) to be traded. Each brokerage house will have its own terms and conditions. It is important to understand those conditions and the liability for any trade.

The broker who handles the trade acts as an agent and will hold the grower accountable for the financial implications of trades made on the grower's behalf. The broker can provide information or advice based on knowledge and experience. The broker does not decide what or when to buy or sell. That is the grower's decision.

When placing a sell order, the broker sells a contract for a given quantity on the grower's behalf on the floor of the WCE. Prior to the trade, the grower indicates the price range in which to sell a contract. The market can move up or down during a trading day depending on trading activity. Each day the price movement is limited to an amount predetermined by the WCE. For canola, the maximum price move up or down is $30/t. Limit moves only occur under very volatile markets.

In any event, the broker will attempt to sell the contract at or better than the price set by the grower. If the market does not reach the price indicated, it means there are no buyers willing to pay the price at which the grower wants to sell on that day. Selling a contract (20 tonnes), is to go short and buying a contract is to go long. Lots are traded either by the Job (one contract) or Board (five contracts), or a combination of these.

When a buyer is found the transaction is submitted to the clearinghouse. The clearinghouse acts as an internal accounting system for the WCE, matching sales with purchases, ensuring proper margins are maintained, and settling accounts.

The clearinghouse simplifies the trading transactions because when the grower decides to buy back a contract, the broker does not have to find the original buyer of the contract. For example, a grower sells five November contracts in July. In October, the grower delivers 100 tonnes of canola to the cash market. The grower now wants to buy back the five November contracts. The broker submits a bid to the trading floor to buy five November contracts. The person who originally bought the grower's contract might not wish to sell it. Another person agrees to sell the grower's broker five contracts. After the trade is made, the clearinghouse acts as the intermediary, allowing the trade to be impersonal but financially secure.

In effect, the grower buys a contract from the clearinghouse, and the seller sells to the clearinghouse. The house does not have to match individual buyers to sellers, but it matches short positions with long positions to ensure the positions balance. This facilitates trade because there is an independent third party, with no financial interest in the trade, verifying that there is an equal number of long and short trades. The clearinghouse enables the grower to liquidate a position without requiring the original person with whom the grower traded to liquidate his/her position as well.

Margin Money

There are two types of margin for growers wishing to trade who are not registered with the WCE: initial margin and maintenance margin. The initial margin is an initial deposit that must be made with a broker when a position is taken in the futures market. Maintenance margin is the minimum amount that must remain in the account after all losses are deducted from the initial margin. The WCE sets the minimum initial and maintenance margin level. Individual brokerage houses may require more than the minimum initial margin. If the grower's account reaches the maintenance level, the broker will make a margin call requesting the grower deposit more money in the account.

This is an important concept which must be understood before entering into a hedge. During the time the grower holds a short position, if the market goes up the grower will be called to provide additional margin money. When the price moves upward, the grower has a contract that has more value, and the grower is required to cover that increased value. A margin call can be quite substantial, depending on the size of the position held. The grower must be prepared to cover it or have a line of credit to cover it or the broker will liquidate the position and likely be unwilling to trade on behalf of the grower in the future.

Here's an example. Suppose the maintenance margin on a 100 tonne lot of canola is $1,000 (or $10/t) and the initial margin is $1,350 or $13.50/t. The grower would have to deposit $1,350 initially. The grower then sells a January futures for $345/t. If the price for a January futures contract increases, the grower is in a paper loss position until the grower buys back the contract, and the grower will be called to deposit more margin.

The following steps are involved:

• Deposit $1,350 with a broker.
• Sell a contract worth $34,500 (Board Lot).
• Price increases $5/t-total increase of $500. The grower now has a contract that is worth $500 more than it was when sold. The grower must cover that increase out of the margin deposit.
• Since the margin deposit will be drawn down from $1,350 to $850, which is below the margin requirement, the grower will be requested to supply $500 to bring the margin deposit up to the initial level of $1,350.

In very volatile markets, the price could move up and the grower could face repeated margin calls. The grower must be able to meet these calls or may be forced to buy a contract back at an inopportune time. An inopportune time would mean a time when the grower wasn't prepared to sell cash canola. To protect the brokerage house, the broker is obligated to take the grower out of the market by buying a contract if the grower cannot meet margin calls.

Margin calls could run into several thousands of dollars depending on the size of the contract held and the amount of price movement over the life of the contract. During busy times of the year it may be difficult to be available when margin calls might come. A three-way arrangement can be set up between the grower, the brokerage house and the grower's bank. This arrangement would allow the broker to contact the bank directly when margin money is required, and draw on a line of credit. When establishing this arrangement, it is important that the banker understands the concept of margin calls (the grower is hedging, not speculating). Otherwise, if substantial draws are made on the grower's line of credit and the banker mistakenly views this as speculation and becomes concerned about security, the grower may be forced out of the market at an inopportune time.

Before deciding to hedge the grower must not only consider the cost of carrying canola to some point in the future (interest and storage), but must also consider the cost of interest on any money that may be required to deposit for margin calls. Ensure the futures price is high enough to cover these costs.

Choosing the Hedge Month (Carrying Costs and Spreads)

Part of the decision-making process in hedging is choosing the month to sell. The first thing to consider is the anticipated delivery period for cash canola. Do not hedge in the same month that canola will be delivered. For example, if selling canola in November, do not sell November futures. Such a close hedge would not allow enough leeway, if for some reason the grower couldn't close out a futures position (buy the contract back). However, if delivering late in the crop year, do not hedge in a new crop month. Available months for canola contracts are September, November, January, March, May and July. Seek the broker's advice in selecting a hedge month.

It is also important to consider the spreads between contract months. As a seller, the grower wants to sell a month that is relatively overpriced to the other months. In a perfect market, the prices of futures months differ by the cost of holding canola (interest and storage) from the nearby month to the future months. However, perfect markets rarely occur. A restriction or oversupply could cause one month to be priced relative to another by as much as the full carrying cost, or an inverse market could occur if there is lack of supply in nearby months. (Buyers bid up the price in order to encourage sales in the short term rather than in the future.)

In a situation of inverse markets, it is advisable to seek professional advice from those experienced in the futures market. Experienced traders should be aware of situations in the cash market, which are affecting the futures market causing the inversion. They can provide opinions as to the overall strength and duration of the higher price levels, and the advisability of selling all or a portion of the crop.

After deciding which futures month to sell, the grower is not locked into that month if the grower cannot sell cash grain prior to the delivery month. The contract can be rolled over into the next futures month. The grower would buy back the futures contract for the nearby month and sell a contract for some future month. Roll the contract over as soon as its known delivery will not occur before the contract month held. If intending to roll over into another futures month, discuss the plan with the broker so that he can watch the market for the most advantageous spread at which to buy back the contract.

The most important factor in determining the spread between months is the quantities for sale. If there are excessive supplies available, prices will tend to be depressed in the nearby months to provide buyers and sellers with incentive to store surplus quantities. If supplies are limited, there is less downward pressure on the nearby months and the market will not be forced to full carry. Full carry means that successive futures months differ in price by the full amount of interest and storage charges that it takes to hold canola from one month to the next.

Any factor that affects the flow of canola to the market will affect the spread between months. These include:

• Price - lower prices restrict the flow because growers become reluctant sellers and consequently narrow the spread between the nearby months.
• Transportation - if transportation is restricted, delivery from elevators to domestic crushers or foreign buyers restricted and the spread may widen until the restriction is removed.
• Interest rates - higher rates increase the cost of carrying canola from month to month, widening the spread.
• Price levels - higher canola prices may increase the cost of carrying (interest charges, etc.), widening the spread.

Points to remember when using the futures market:

• Understand the difference between hedging and speculation.
• Remember margin calls may occur and they must be covered.
• When weighing one decision over another, calculate the cost of interest associated with either margin calls or carrying the canola into the future.
• Know the cost of production, otherwise a price target at which a margin can be locked in can't be established (sometimes the decision is to minimize a loss rather than locking in a profit).
• Establish a good relationship with the banker so that the banker understands the marketing plan and the intent behind hedging.
• Talk to a number of brokerage houses before selecting a broker. Full and honest communication with the broker is important.

Cash Markets

In the previous sections, it was explained how futures prices are determined, how spreads are established, and how the cash price relates to the futures price. Here's a quick review:

• Futures price is established in a public forum based on supply and demand.
• Spreads between futures months reflect what the market is willing to pay to carry (storage and interest) canola from one futures month to the next.
• The spot cash price differs from the nearby futures in the amount of the cost of holding the canola in position until the futures month (plus explainable costs of futures pricing point vs. cash pricing point). It may also reflect short-term supply or demand conditions, which produce a price either above or below the actual carrying cost.

A fundamental principle is that the cash and futures prices converge (come together to the point of reflecting explainable costs) at the market location as the futures approaches maturity.

The difference between the futures and cash price or street price is called the basis. In a normal market the basis bears a predictable relationship to the futures.

Relationship of Cash to Futures

In the case of the cash market, the carrying charges at any point in time will gradually diminish until they become zero during the contract delivery month. If conditions exist which will affect the futures markets differently than they affect the current cash markets, the basis may diverge from the traditional storage, interest, handling charge and storage space opportunity cost pattern. Under such circumstances, and in situations where information is sound and the product can be moved, arbitrage will occur. Arbitrage is profit-motivated behaviour, which buys in a discounted market and sells in an overpriced one. When there are no restrictions in the market, arbitrage serves to bring cash and futures prices back "into line." Whenever the difference between the cash and futures prices (basis) exceeds the cost of bringing the cash commodity forward to the futures position, arbitrage should set in to restore equilibrium.

For example, assume the full cost of carrying canola to the November futures delivery month is $30/t but the existing basis is $40. With the prospect of a $10/t profit, traders would sell a futures contract and buy the cash commodity in preparation for delivering on the futures contract. This results in a relative increase in supply of the futures contract, and a relative increase in demand for cash canola. This will cause the futures price to fall and the cash price to rise.

The basis between the street and futures price includes a number of items as shown in Table 11.

Table 11. Example of Basis Calculation for Canola (Delivered to Saskatoon, SK)

Description	Cost ($/t)	Price ($/t)
Theoretical Futures Price		330
Primary Elevation*	7
Administrative Costs and Handling Risk*	3
WCE and Brokerage Costs*	1
Carry Charges (assume 30 days of carry)*	3
Quality Adjustments	0
Location Premium/Discount	0
Opportunity Cost*	5
Risk*	0
Miscellaneous*	1
Theoretical Basis		(20)
Theoretical Cash Bid		310

* Budgeted and actual costs will vary over time and among companies.

If a grain company is quoting a basis on canola to be delivered several months into the future, the risk is its costs will be considerably different at the time of delivery. It is understandable that the company will add a cost to its basis that reflects this risk. In addition, the company may already have several months' supply of canola in store. If it takes in another month's supply of canola it may not only have a real cost of carrying the canola, but it may also be restricting its ability to handle other grains. As the company makes more money from shipping stocks than storing them, it will tend to penalize the slower moving grain by adding additional months of carrying charges.

It may seem difficult to understand why prices vary between companies, but it is simply a question of supply/demand. One company may be shipping its canola faster than another because it has lined up more sales. Another company may be buying canola to crush for oil and meal rather than for seed for export. If one company has two months smaller supply of canola in store, it could afford to pay more per tonne for the product. Storage costs in an elevator are typically are about $2.40/t per month (without considering the cost of the money tied up in owning canola).

Any conditions that affect the quantity of canola available for sale will affect the basis. The local supply/demand situation is probably the most important factor affecting the basis. If there are surplus stocks, companies can bid less (widen the basis) and still acquire their supplies. On the other hand, if supplies are low some companies will find themselves low on stocks and will raise their bid (narrow the basis) to acquire additional stocks.

"Unpriced" Marketing Strategies

Growers may want to leave their canola "unpriced" because an analysis of market conditions may indicate prices are likely to be higher in the future than they are at present. Another reason for using an unpriced strategy is the desire to hedge or contract only a portion of the canola in case of lower than anticipated production or restricted delivery opportunities.

Growers could decide to store their canola on-farm for sale at a later date. Theoretically, the seasonality of canola production should result in the lowest prices shortly after harvest when supplies are highest. The price increases from harvest time to the period just before next year's harvest should reflect the storage and interest costs involved in holding inventories.

When considering an unpriced canola marketing strategy, include carrying costs such as interest and storage in the analysis. When interest rates increase, the cost of holding canola becomes a more important factor.

In Table 12, the cost of holding canola at various interest rates and prices has been calculated. If the grower could receive a street price of $400 for canola at harvest in October, but decides to hold it until February, the grower would require a price of at least $410 in February to be as well off as selling in October, when interest rates are 6%.

Table 12. Monthly Cost of Holding Canola ($/t/mo)

Interest Rate/mo	$200	$250	$300	$400
4% (0.33%)	$0.67	$0.83	$1.00	$1.33
6% (0.50%)	1.00	1.25	1.50	2.00
8% (0.67%)	1.33	1.67	2.00	2.67
10% (0.83%)	1.67	2.08	2.50	3.33
12% (1.00%)	2.00	2.50	3.00	4.00
18% (1.17%)	2.33	2.92	3.50	4.67

The above costs do not include any charges for cost of storage facilities

When deciding whether to store canola on-farm or sell immediately, remember it adds an additional risk-the potential for canola to deteriorate during storage.

An alternative to a single cash price is price averaging. Growers can adopt this approach without resorting to the futures market or contracting. Growers can seek to secure the average market price over the course of a crop year by making sales at regular intervals, weekly, monthly or quarterly, over the year or any period during the year.

When using price averaging the grower is not compelled to stay with his/her sales spreading pattern. If it's believed prices are sufficiently high, or they are likely to go down, the grower can sell out the balance of the crop at any time.

A Note on Price Quotations

When considering delivery options and comparing prices offered by the various alternatives, compare apples to apples. Remember the relationship between futures, cash and street prices. (Recap: futures price is an indicator of the approximate value of canola in the par region some time in the future; Vancouver cash price is a price for canola in export position now; street price is a price for canola quoted at a specific location in the country.) Don't be misled by trying to directly equate the futures price with the local country price.

This is particularly important when comparing prices quoted by canola crushers and grain handling companies. Usually a grain company will broadcast daily prices (less the applicable rail freight) for any one location. Canola crushers generally quote "Free On Board" (FOB) the plant.

The canola crusher and grain company are generally concerned about two different markets, one domestic and the other international. While the value of canola is ultimately based on the value of oil and meal internationally, market circumstances for the crusher and grain company will differ over the year, depending on the particular requirements of each market at a given time. It is reasonable, therefore, to expect prices quoted by grain companies and crushers to vary.

Options on Futures

Options on futures were introduced to the WCE in the fall of 1991. Options offer growers a method of using the derivatives market for price protection without the risk of margin calls. Options on futures are a marketing tool, which can be used to capture pricing opportunities and reduce risk while maintaining the ability to take advantage of market price changes.

Purchasing an option is sometimes described as being similar to purchasing an insurance policy. The cost of the option is referred to as a premium and the premium varies with the amount of price protection desired. As with an insurance policy, the grower may not necessarily "collect" or exercise the option. If the option is not exercised, it expires at the end of a specified period. Options on canola futures expire on the third Friday of the month prior to the underlying futures month. On that day, the right to exercise the option is lost.

The following definitions are excerpted from publications of the Winnipeg Commodity Exchange. For more complete details regarding options on canola futures, contact: Winnipeg Commodity Exchange Inc. (WCE), Suite 400, 360 Main St., Winnipeg, Manitoba R3C 3Z4. Phone: (204) 925-5000.

There are two types of options-put and call. Buyers of options are not obligated to take any action if it is not profitable. The total risk in buying the option is the cost of the premium.

Put options provide the buyer with the right to sell a futures contract at a specified price. The buyer may wish to buy a put option if it's felt the market is likely to go down and protect against a price decline. Others may buy a put option as a low-risk speculation to take advantage of a market move lower.

Call options give the buyer the right to buy a futures contract at a specific price in a defined time period. Canola crushers may buy a call option if they think there is a good chance that the market will move higher and they want to protect themselves against this upward shift in prices. Others may buy a call as a low-risk speculation to take advantage of a higher market.

The buyer (holder) controls all option contracts. The buyer decides what to do with the option as follows:

• Exercise - the buyer can exercise the option to produce a short (put) or long (call) futures position at the strike price specified in the options contract. Writers of options receive the premium from the buyer. In return, they assume the risk of any adverse price movement. (Buyers of options are reducing risk, while writers of options are accepting risk.) If an option buyer chooses to exercise his right, the buyer receives a futures position and a writer must take the opposite futures position at the designated strike price. Exercising an option places the holder in the futures market. Exercising an option is a move from a position with limited risk (the options market) to a position with unlimited risk (the futures market). Margin calls would now apply. To capture the intrinsic value of the option, place an offsetting futures order to get out of this new futures position. If an option still had some time value, it would normally be more profitable to offset it in the options market and take advantage of the remaining option premium.
• Offset - the options buyer can sell the option, offsetting the original purchase. An options buyer may want to offset his position and capture any value remaining in the premium. This allows the buyer to benefit from an increase in the option premium without actually moving into the futures market. (If the premium has shrunk, offsetting can reduce the cost of owning the option by regaining some of the premium.) In effect, the trading of options is trading the value of the premium. Therefore, as futures prices change so will the value of the option's premium. Offsetting an option allows the buyer to capture that change in value.
• Expiry - the buyer can allow the option to expire. If there is very little time left before the option expires, and no economic benefit in exercising the option, the option has little remaining value. In this case, the holder of the option can simply allow the option to expire.

Trading Options

Option contracts are traded at WCE by open outcry of competitive bids and offers-in the same manner as futures contracts.

Options on canola futures are offered on the six delivery months of canola futures-January, March, May, July, September and November. Strike prices are in $10/t increments. Strike prices are made available in a range above and below the current futures contract price for each month. As the futures contract price moves up or down over time, additional strike prices are added as required, but are not removed once they are made available. For example, if November canola is trading at $322/t, strike prices for both call and put options might be as listed in Table 13.

Table 13. Examples of Strike Prices

Calls	Puts
350	350
340	340
330	330
November Canola Futures at $322
320	320
310	310
300	300
290	290

For each futures contract trading, there are at least seven option strike prices (series) quoted. Buyers and sellers will call out their bids and offers for each contract. Call options and put options are completely separate and distinct contracts. If a grower bought a November canola 320 put option, and later wished to liquidate it, the grower would sell a November 320 put option.

Option Premiums

An option premium is made up of two components: intrinsic value + time value (also called extrinsic value).

Intrinsic value is the positive difference between the option's strike price and the current futures price (a premium cannot have a negative intrinsic value). For a call option, the strike price must be below the current futures price for the option to have any intrinsic value. For a put option, the strike price must be above the current futures price for the option to have any intrinsic value.

Time value (or extrinsic value) is the amount a buyer pays to a writer in return for the writer assuming the risk of an adverse futures price movement. Everything in the premium of an option that is over and above the intrinsic value is considered time value.

Time value has several components. It is determined largely by the following factors:

• Time remaining to expiration - options with a long time remaining to expiration (for example, nine months) will normally be higher priced than options with a shorter time remaining (for example, six weeks). The more time remaining on an option, the greater the number of market unknowns. Therefore, the possibility is greater that the futures price will move in favour of the options buyer. Additionally, the interest cost of putting up margin money from the point of view of the option writer is also reflected in the time value of an option's premium. This time component of the premium will decline over the life of the option. At expiration, an option has no time value.
• Volatility of the underlying futures price - volatility is the degree to which the market price fluctuates. Generally, options on futures with high volatility have higher premiums than options on futures with lower volatility. Higher volatility means higher risk to the writer. Since the canola futures market has a strong seasonal influence, related to the growth and harvest of the crop, the volatility reflects this seasonality. In the spring, the number of unknowns over the growing season is large, and, therefore, the potential volatility is significant. In the winter months, unknowns still exist but are generally fewer and potential volatility is lower. When the volatility of the underlying futures contracts is perceived to be high, option premiums will be higher. When the volatility is low, the option premium will also be lower.

Option Premiums and Future Prices

Assume it is spring and November canola is trading at $320/t. The options quotes in Table 14 might be displayed.

Table 14. Option Premiums

Strike Price	Puts	Calls
290	1.90	31.90
300	3.90	23.90
310	6.60	16.60
320	11.20	11.20
330	17.30	7.30
340	24.50	4.50
350	32.60	2.60

Table 14 shows theoretical option premiums for 14 separate option contracts (seven puts and seven calls). Call premiums are higher for those options with strike prices below the futures price because the buyer is purchasing the opportunity to buy futures at a lower price than the current market (the option has intrinsic value). Put premiums are higher for those options with strike prices above the current futures price. The buyer is purchasing the opportunity to sell at a higher price than the current market.

An option is said to be "in-the-money" if exercising it would yield a profitable futures position. An option is said to be "out of-the-money" if exercising the contract would yield an unprofitable futures position.

Call options with strike prices lower than the current futures price are in-the-money. Put options with strike prices higher than the current futures prices are also in-the-money.

Call options with strike prices above the current futures price are out-of-the-money, and put options with strike prices below the current futures are also out-of-the-money. (An option is out-of-the-money if exercising it would yield an unprofitable futures position.)

The term "at-the-money" refers to those options with strike prices equal or very close to the current futures price.

Using Options on Canola Futures

When using futures contracts or option contracts as pricing vehicles, the delivery time frame or purchase of the product normally determines which futures month is chosen. A grower looking to price a currently seeded canola crop in the spring for fall delivery, would likely use the November futures or options contract. An exporter who sold canola in March to a Japanese buyer for delivery in the first week of May would likely use May canola futures as the pricing contract because it is the closest futures month.

Once the month is selected, if options will be used an appropriate strike price must be chosen. Since options can be viewed as a form of price insurance, the relevant question is how much insurance does the buyer want to purchase?

Assume that November canola futures are trading at $330/t and a canola grower is evaluating the three put options in Table 15.

Table 15. Put Options: Strike Price - Put Premium = Minimum Selling Price

Strike Price ($)	Put Minimum	Minimum Selling Price
320 Out-of-the-money	7.00	313.00
330 At-the-money	11.50	318.50
340 In-the-money	17.00	323.00

An out-of-the-money put option has relatively low premiums, but locks in a selling price below current market levels. However, if prices move higher, the net profit may be higher than if an at-the-money option had been bought because the cost of the option is lower. An in-the-money option will cost significantly more than an out-of-the-money option, but it locks in a higher overall price if the market price falls. Which strike price to choose depends on the market outlook, the current price level relative to historical price levels, and the individual's assessment of what will serve his needs.

Option Strategies for Canola Growers

Buying put options to establish a minimum selling price (hedge)

Assume it is spring and seeding canola is just finished. November canola futures are quoted at $326/t and normal basis level at harvest time is about $24/t under the November futures contract. This futures price represents a potential cash price of $302/t.

If a good canola crop develops in Canada, prices will likely decline by harvest. On the other hand, if weather conditions are dry and the market outlook uncertain, higher prices will probably develop. Buying a put option can lock in a floor price and still allow the grower to benefit from higher prices in the cash market (if the crop is not already sold). If purchasing 10 November canola 330 put option contracts at $14/mt, the grower would establish a minimum selling price on 200 tonnes of the canola crop as shown in Table 16.

Table 16. Selling Price

Strike price	$330
Option premium Expected basis	-$14 -$24
Cash price (Floor price)	$292

If by early September prices have fallen to $294/t for November canola futures, the November canola 330 puts would be worth $37/t ($330 - $294 = $36 intrinsic value, plus $1.00 time value) in this example. At the same time, the cash price would be $270/t ($294 - $24 = $270), assuming the basis was indeed $24/t. The plan may be to sell the cash canola and offset the option position to arrive at the results in Table 17. on the portion of the crop "protected" by options.

Table 17. Offset Option Position

Cash Market	Nov. Canola Futures Price	Options Market	Basis	Action
Spring	$326	Buy Nov. 330 puts at $14 premium	$24	Bought put
Sept. Sell Cash at $270	$294	Sell Nov. 330 puts at $37 premium gain = $23/t	$24	Sold cash and sold puts
Net selling price = $270 cash futures less $14 premium plus $37 profit on sold options = $293/t

Note: transaction/brokerage fees not included in this example
(Note: This price is $1/t above the targeted minimum selling price because the options were sold with $1/t of time value remaining in the premium.)

If November futures had risen to $368/t by harvest, the net selling price is shown in Table 18.

Table 18. Net Selling Price

Cash Market	Nov. Canola Futures Price	Options Market	Basis	Action
Spring	$326	Buy Nov. 330 puts at $14 premium	$24	Bought put
Sept. Sell Cash at $344	$368	Sell Nov. 330 puts left to expire	$24	Sold cash and puts expire
Net selling price = $368 futures less $24 basis (or $344 cash price) less $14 premium = $330/t

Note: transaction/brokerage fees not included in this example.

Another benefit of using put options to hedge a growing crop is the risk reduction. If the crop is reduced by adverse growing conditions, the grower will not be forced to "buy back" the hedge (potentially at a loss) as would be required with other marketing alternatives. The option would simply be allowed to expire with no remaining value.

Buying call options as an alternative to storing the crop, or to replace lost crop potential during the growing season (speculating).

Rather than speculate on rising prices with stored canola, a grower may choose to sell cash canola and buy call options. As the price of the futures contract increases, the premium of the call option should also increase (especially if the option has intrinsic value-when it is in-the-money). Since the grower is no longer holding the physical canola, the grower may choose to buy a call option with the objective of taking advantage of an increase in the premium.

For example, if an at-the-money 310 call is purchased (futures are also around 310) for $10/t, and the futures price increases to $350/t, the call option premium should increase to, $45/t ($40 intrinsic value plus $5 time value). The net profit would be ($45 - $10 = $35/t)-the difference between the purchase price and the selling price of the option premium.

Buying call options may offer greater price risk management than a long futures position because the maximum loss with an option is always limited to the cost of the original premium paid.

Table 19 is an example of comparing buying futures contracts with buying calls. Assume it is November, the canola crop has just been sold and the market shows the following prices.

Table 19. Buying Futures Contract vs. Buying Calls

March Canola Futures at $310.00/t
March canola call options:
Strike + premium = breakeven with futures at:
320	5.50	325.50
310	10.00	320.00
300	15.00	315.50

Note: transaction/brokerage fees not included in this example.

The choice of strike price will depend on premium values and market outlook. Assume you choose to buy an at-the-money 310 call for $10. Table 20 compares the potential of this options position to a long futures position, given various market prices that might exist by February.

Table 20. Potential of Options Position vs. Long Future Position

March Futures in February	Bought 310 Calls	Bought Futures
350	$30	$40
340	$20	$30
330	$10	$20
320	0	$10
310	($10)	0
300	($10)	($10)
290	($10)	($20)
280	($10)	($30)

Note: transaction/brokerage fees not included in this example.

The call option allows a profit from increases in the premium's value if the futures market rallies. It also limits loss to the $10/t original premium paid if the futures market declines. If a futures contract was purchased at $310/t, this would also be profitable if the futures market rallies. However, the loss would be unlimited if the futures price declined. Initial margin money must also be deposited to hold a futures position, and margin calls must be met as the market moves against the position held.

The same approach of buying call options to replace sold inventory can be applied to a growing crop. If the western Canadian canola crop is deteriorating due to poor growing conditions, a grower can buy call options to replace his/her lost crop potential. Deteriorating crop conditions will usually lead to rising market prices, and buying the call options allows the grower to participate in the rising market.

Delivery Options

Elevator and Crushing Companies

A variety of contracts are available to canola growers through either grain handling companies or canola crushers. Before entering into a contract, read the contract to understand its terms and obligations. The terms of the contract will vary by type of contract and company offering the contract.

Production Contract

A production contract is an agreement that the grower will deliver canola produced on a specific number of acres to the contracting company. Production contracts are most often offered by crushing companies. Some elevator companies may offer production contracts, particularly for specialty trait canola.

Signing the contract commits the grower to delivering the production from a given acreage, and the company to accept the crop. No agreement is made to the total volume to be delivered or the price. The volume is committed after the crop has been harvested. Prices can be established at any time using one of the following options:

• at time of delivery
• deferred delivery contract
• deferred pricing contract

It is important to carefully read the production contract. Some companies specify grades to be delivered with other grades being accepted only at the company's option. The contracts may also specify quantities. Understand what is being signed. Some companies have a charge for releasing a grower from a signed production contract. Check the costs and conditions associated with obtaining a release from a contract.

Deferred Delivery Contract

This type of contract is in effect a hedge, a perfect one at that, because it allows the grower to lock in both a price and the basis. It is a contract where price is agreed to now for a specific delivery period at some time in the future. The advantage to this hedge is it does not require margin to be put up and it does not require the grower to maintain the maintenance margin when the market goes against him/her. On the other hand, it limits the choice of company to which the crop can be hauled. The quality of canola, which can be delivered under the contract, is specified in the contract and the buy-out costs may be significant

Basis Contract

This contract is much less common than the deferred delivery contract and may not be offered at all times. The contract is mutually negotiated between the grower and the company. An agreed basis level is established at the time the contract is signed. The grower can price canola anytime within a specified period. The delivery price is then calculated using the specified futures month price minus the agreed basis.

Using this procedure, though, the grower is still a speculator because prices may rise or fall during the period between the signing of the contract and actual delivery. However, the basis risk has been eliminated in the interim. The grower can lock in the price either with the company or by taking a futures position.

Deferred Pricing Contract

The grower can deliver canola to either a crusher or elevator or put the canola into storage and price it at a later date. Canola crushers use grain receipts, while elevator companies use storage tickets, as the contractual arrangement indicating the quantity of unpriced canola the grower has in store. The grower has 90 days from the time of delivery to price the canola. The grower can benefit from any price increase or basis narrowing, but also can lose from a price decline or basis widening. If the grower does not price canola within 90 days, the company automatically does it for the grower, and the grower must accept the market price on the 91st day.

The advantage to deferred pricing is that it lets the grower deliver canola when it is convenient or when space is available, without requiring that the grower accept the current market price. The grade, weight, dockage and moisture content of the canola is settled at time of delivery.

Many growers tend to leave pricing canola until near the end of the 90-day period. If many growers price in the same time frame, it can cause a temporary price decline, such as is traditionally the case around harvest. It has been observed that prices tend to trend downward about 90 days after harvest deliveries.

Grain Pricing Order or Target Price Contract

Some companies allow the grower to place an order with an agent for a specified price. If the market reaches that price, the quantity of canola committed is priced. This option is available for either canola in-store in the elevator or canola still on the farm. In the case of in-store canola, if the target price is not reached within 90 days the canola is automatically priced on the 91st day. For canola held on the farm, the grower can have an open pricing order. This means there is no time limit on the contract. When the target price is reached, the canola is delivered.

The disadvantage of this type of contract is that it can isolate the grower from the marketing decision. If the grower decides, once a target price is set, to no longer follow the market, the following may occur:

• The grower might miss a peak in the market where the price nears the target but then falls.
• The canola might be priced early in an up-trending market.
• The canola might not be priced because of a downtrending market.

The advantage, of course, is the grower can put the pricing order into effect at busy times of the year when it is difficult to follow price moves.

Summary

The Elevator System

Grain handling companies and crushing companies offer similar services to canola growers. The major difference is in the delivery of those services. Grain handling companies have an established network through their elevators, and consequently are in close proximity to growers. When marketing to the local elevator growers are dealing with a familiar person who, together with the company, will look after all the details associated with the handling, shipping and sale of the grower's canola. Generally grain handling companies offer:

• deferred delivery contracts
• basis contracts
• deferred pricing contracts
• pricing at time of delivery
• target price contracts/grain pricing orders

However, it is important to note that prices offered by grain companies in similar regions can vary significantly depending on their needs. Variability can be as much as $40/mt so it is important to shop around.

Crushing Companies

Crushing plants, in most cases, do not have as extensive a network in the country as do grain companies. However, this need not make marketing to a crusher any more difficult than to an elevator company. All crushers have a telephone system allowing pre-pricing to be done over the telephone. Telephone calls between the grower and company representative are recorded and serve as binding agreements between the two parties. All crushers offer a trucking allowance toward trucking costs, and in most cases will arrange transportation from the farm gate to the plant. Generally, crushing companies offer:

• production contracts
• deferred delivery contracts
• deferred pricing contracts
• pricing at time of delivery
• basis contracts

Canola crushing plants require a constant supply of canola to keep their manufacturing process running efficiently. If sufficient canola cannot be sourced directly from growers, crushing companies will purchase the required quantities from elevator companies.

Since every company is different, be sure to check the various contracts available and their terms.

Producer Cars

Using a producer railway car for delivering canola lets the grower deliver to a confirmed export sale. A producer car is a railway car shipped by the producer (grower) of canola or other grains. Canola loaded through a producer car differs from elevator handled canola in two ways. No elevation is charged against it and consequently there is a narrower basis for canola marketed in this way. Secondly, grade and dockage is assessed by an inspector of the Canadian Grain Commission at the port upon unload. If a grower decides to ship a producer car, an application form must be completed and submitted along with a $20 fee to the Canadian Grain Commission.

For additional information contact:

Producer Car Officer
Canadian Grain Commission
303 Main Street
Winnipeg, Manitoba R3C 3G8
Phone (204) 983-3368

Marketing Glossary

Actuals

the physical commodities.

Arbitrage

simultaneous purchase and sale of the same quantity of the same commodity in two different markets, either in the same country or in different countries. Used to take advantage of what is believed to be a temporary disparity in prices.

Asked

the price at which sellers will trade. This is usually accompanied by a bid-the price which buyers are willing to pay. The bid price is often a better indication of the true market level.

At-the-money option

call and put options are at-themoney when the price of the underlying futures is the same as the strike price.

Basis

the difference between the quoted street or cash price of a particular commodity and a specified futures contract price for the same commodity.

Basis contract

a contract where the basis but not the actual price is established at time of delivery. When the grower decides to sell grain, the price is established by subtracting the agreed-upon basis from the hedge month.

Basis risk

the risk associated with unexpected changes in the basis between the time a hedge is placed and the time it is lifted.

Bear market

one where large supplies and/or poor demand cause a decline in price.

Bid

an offer to purchase a commodity at a specified price.

Board lot

at WCE 100 tonnes (equalling five units of trade or five futures contract).

Break

a sharp price movement. A market may break upward or downward. The term is reserved by some for price declines.

Break-even point

the future price (or prices) at which a particular strategy neither makes nor loses money. A dynamic break-even point is one that changes as time passes.

Bulge

a large price rise.

Bulls

those who believe that prices will rise in the future.

Bull market

one where small supplies and/or strong demand cause prices to rise.

Bull move

the term used by some chartists to indicate where daily highs, lows, and closes are higher than previous indications.

Buy a contract

when a contract is purchased on a futures market, the buyer is obligated to accept delivery of the amount of canola specified in the contract during the designated delivery month for which the contract was purchased. In hedging, a grower would buy a contract to "close out" his/her position in the market. That is, a contract would be purchased to offset the previous sale of a contract and remove any obligation the grower has to the futures market.

Buy on close

an order to buy within the closing price range at the end of a day's trading session.

Buy on opening

an order to buy within the opening price range at the beginning of a day's trading session.

C and F

cost and freight paid to destination.

Call option

a contract that gives the call option purchaser the right, but not the obligation, to buy a futures contract at a specific price during a specific time period. The call option seller is obligated to sell futures to the call option purchaser if the call option purchaser exercises the option.

Carrying charges

the combined costs of interest, storage and insurance incurred in the storage of grain.

Carrying charge market

a futures market in which the nearby months are selling at a discount under the distant months.

Carryover stocks

the stocks of grain in all positions at the end of the crop year.

Cash

the actual physical product or commodity as distinguished from futures. Also known as "cash commodity," "spot commodity" or "actuals."

Cash price

the price paid for immediate delivery at a port location.

Charting

the construction and use of charts or graphs in the technical analysis of futures markets. Price movements, average price movements, volume and open interest are usually graphed.

CIF

costs, insurance and freight to port of destination, paid or included in price.

Class

all put and call options contracts on the same underlying future.

Clearinghouse

a separate agency or corporation working in conjunction with the commodity exchange to match up buy and sell orders and through which futures contracts are offset or fulfilled. The clearinghouse also ensures that financial settlement is made through its facilities.

Closing price

the price at the end of the futures trading session.

Commission house

a company that buys and sells actual commodities or futures contracts for the accounts of customers.

Confirmation

a document sent by the brokerage firm to its client when a futures transaction is conducted-either a purchase or a sale. It generally shows the date of the trade, delivery month, price and quantity.

Covered option

the seller of the option owns the underlying commodity itself or has a futures position.

Deferred delivery contract

a contract in which the grain is priced on the basis of the prevailing market in advance of the actual delivery of the grain.

Deferred futures

the futures, relative to those currently traded, that expire during the most distant months (also see Nearbys).

Deferred pricing contract

delivery of canola to an elevator or crushing plant and deferral of the settlement price and payment until some later date.

Delivery month

the calendar month in which a futures contract matures and contract settlement is required.

Delivery points

those points designated by futures exchanges at which commodities may be delivered to satisfy a futures contract.

Discount

indicating one price is below another price.

Early exercise (assignment)

the exercise or assignment of an option contract before its expiration date.

Exercise price

same as the strike price for listed options.

Expiration

the time at which an option no longer entitles its owner to purchase or sell a specific futures contract.

Expiry date or expiry day

the day when the owner of the option loses the right to exercise the option.

Extrinsic value

same as time value.

Fill

to execute an order.

FOB

Free On Board, a sales expression which places the obligation of arranging the freight on the buyer of the goods.

Forward contract

an agreement between seller and buyer where the seller agrees to deliver a specific quantity and quality of commodity to the buyer at a specific time and location. When the seller delivers, he/she will receive a previously agreed upon price.

Forward price

an agreement between a buyer and seller that establishes price prior to delivery.

Forward selling

forward contracting in which the price is fixed at the time the contract is entered.

Full carrying charge

in a futures transaction, the cost (storage, interest, etc.) of taking actual delivery in a given month, storing the commodity and redelivering against the next delivery month.

Fundamentals

those factors which affect the price of a commodity such as supply and demand, weather, political actions, etc.

Futures

a term used to designate the standardized contracts covering the purchase and sale of commodities for future delivery on a commodity exchange.

Futures contract

a term used to designate the standardized contracts covering the purchase and sale of commodities for future delivery on a commodity exchange. Also known as "futures."

Futures price

an indicator of the approximate value of canola in a port position at some time in the future.

Hedging

a transaction to minimize the risk of loss due to adverse price fluctuations. Hedging involves the temporary substitution of a future market transaction for a cash transaction. This is accomplished by holding equal and opposite positions in the cash and futures markets.

In-the-money option

a call option is in-the-money when the price of the underlying futures contract is above the strike price. A put option is in-the-money when the price of the underlying futures contract is below the strike price.

Intrinsic value

the value of an option if it were to expire immediately with the underlying future at its current price; the amount by which an option is in-the-money.

Inverse market

a futures market in which nearby months are selling at a premium over distant months. These price relationships are characteristic of situations in which supplies are currently in shortage. Normally, because of carrying charges (storage and interest), the highest prices are quoted for distant months.

Job lot

at WCE - 20 t or one contract.

Leverage

(1) The ability to control a large amount of money with a small amount of funds. (2) In investments, it's the attainment of greater percentage profit and risk potential. A call holder has leverage with respect to a futures holder-the former can have greater percentage profits and losses than the latter for the same movements in the underlying future.

Life of contract

the entire time a contract is available for trade.

Limit move

a limit move is the maximum price movement allowed under the predetermined regulations of the WCE (canola currently $30/t).

Long

one whose net position shows an excess of open purchases and/or inventories over sales (opposite to