The Four Steps of Risk Analysis
There is always risk in the market, but the question that needs to be answered is whether that risk is acceptable which of course is dependent on the “risk tolerance” a producer has. A higher leveraged farmer should have a different risk appetite than one who has no or very little debt. This is why VantageRM's risk analysis uses a 4 step approach to dealing with risk.
These 4 steps are as follows:
- Detecting what type of risk is present (there is always risk)
- Classifying that risk as acceptable or unacceptable
- Quantifying the amount of risk
- Rectifying the risk through a strategy dependent on a producer's risk tolerance
Strategies must be tailored to the producer’s risk appetite as there is not a “one fits all“ approach that will work.
Detecting the Type of Risk
There is always risk in the market, but sometimes that risk is acceptable for a seller. Of course, that is a time when it may be unacceptable for a buyer. Detecting the risk then, has two factors. One factor is the directional risk, and the other factor is the level that risk represents.
As the risk is detected, it will be classified as acceptable or unacceptable, dependent on a producer’s appetite for risk. This is defined fully in our “Producers Class” on risk; but in general, there are three levels of risk tolerance - Low, Medium and High.
Here we use the market to tell us what the risk in price is when it has been classified as unacceptable for a certain risk tolerance. We use options and volatility to give a producer the market risk in the short term, medium term, and long term.
If the risk is unacceptable and the need is great enough to rectify the high threat of market value loss, then strategies can be deployed to contain the potential damage. These strategies will be dependent on the “risk tolerance” as determined by the individual member.