Cross Hedging Grain Sorghum in Missouri

Annually between 1994 and 1998 over 400,000 acres of grain sorghum have been harvested in Missouri with an average yield of 86/bushels/acre. The average value of production during this period was over $90 million. Grain sorghum (milo) is an important crop for some Missouri producers. Many sorghum producers also produce corn, soybean, or wheat. Each of these commodities has an actively traded futures market where producers can hedge all or a portion of their production. There is no futures market for sorghum (milo). Thus, producers of sorghum may seek to produce alternative crops for which they can hedge. Hedging is defined by Purcell (p. 354) as, "the establishing of a position in the futures market that is equal and opposite the position, or intended position, in the cash market with an objective of transferring cash price risk to someone else." Hedging is for cash commodities that have active futures markets. However, sorghum producers can cross hedge sorghum production. Cross hedging is the process of hedging a cash commodity in the futures market of a different, but related, commodity. Some of the explanation below was taken verbatim after obtaining permission from Graff et al. Cross hedging will generally work well for reducing price risk if (1) the price of the commodity being cross hedged and the price of the futures commodity are closely related and follow one another in a predictable manner, meaning hedged price risk is less than unhedged price risk and (2) large enough quantities are being traded to meet cross hedged futures contract size specifications. Cross hedge price risk refers to the price actually received by hedging relative to what was expected, and unhedged price risk refers to general price level variability. The focus of this fact sheet is to introduce the concept of cross hedging and to recommend strategies for cross hedgers of grain sorghum. These techniques are applicable to both long hedgers wanting to reduce input price risk and short hedgers trying to set selling prices. They can be applied to marketing strategies involving either futures or options markets.