Larry Martin: Use futures and options to help manage risk

Date posted: January 11, 2018

Dr. Larry Martin

"I work with a lot of people managing risk and pork futures are one of the hardest to trade."

Dr. Larry Martin started his presentation to the 2018 Banff Pork Seminar in Banff, Alta. with that statement. He had the tough task of covering what he teaches in a several day course on futures trading and risk management in a 45 minute plenary presentation. Judging by the number of people who lined up to talk to him as his presentation ended and people headed to break, the veteran market analyst and farmer risk management coach reached his goal.

Martin works with farm and agribusiness clients to manage price risk. He describes the issues in managing price risk as including failing to sell at high prices and then taking low ones; forward contracting at relatively low prices and foregoing opportunity; and, selling futures and then having large margin calls.

"Those are manifestations of fear and greed," he says. "We constantly have 'bull bag' and 'bear bag' of things to consider; that's what makes a market. It is particularly relevant in red meat at the moment - bearish supply numbers, bullish demand, uncertain trade policy. So the question producers should be asking is whether there are any techniques that can help manage some of these issues in uncertain markets."

The most frequent, but least relevant question people ask is, says Martin is "What do you think these hog prices are going to do"? That's the wrong question, he says. The right question is "As prices change, where do I take action and what action should I take"?

Producers need a plan, he says. The objectives are to characterize the conditions that give rise to the current uncertainty, define some methods of reading price charts that can help change the question from "where do I think prices are headed?" to "where should I take action"?

A plan should suggest and illustrate some trading rules for deciding when and what actions to take.

Martin walked his audience through six chart formations that they could use to help them interpret price trends, to decide where prices are going and what actions they should take.

One of the biggest challenges for producers is discipline, says Martin. Using charts systematically forces a person to take a view of where the market is relative to its recent past – helps identify highs and lows.

This information can be used for forward contracting, but producers don't need to use futures and options to get value from charts. Obviously, they are not always going to be correct, but it helps identify places with high probability of doing well on futures or options. It helps reduce "losses" by limiting margin payments, or it helps retrieve some of any price appreciation after contracting with Calls.

It gives disciplined decision rules that helps keep losses smaller.