There are multiple ways to sell grain and not every option is appropriate for every producer. The list below starts conservative with standard forward contracts and then increases in aggressiveness as you move down the list. Some options increase the potential price received but could also produce final prices below current market values based on conditions at the time. If you are interested in any of the below options please call or come by to discuss which option is appropriate for your operation. Prices listed in the examples shown are subject to change given current market conditions.
Cash Sale/Spot/Daily to Arrive:
FUTURES + BASIS = CASH
This is the most common way grain is sold. The producer calls the local elevator and is quoted a cash price for a particular commodity for a nearby delivery period. If he sells his grain on a cash sale, he has locked in both the futures price and the basis, effectively transferring all price risk to the buyer. Shipment is usually “buyer’s call” (whenever the elevator can take the grain or immediate if it is already in storage) and payment is made immediately or deferred.
- Easy, no complications
- Cash price, quantity, and delivery are known.
- Risk of price decrease is eliminated.
- No service or storage charges.
- Income can be deferred.
- Price locked in. Can’t participate in a market rally.
- Payment not received until grain is delivered.
- Possible penalty for cancellation.
Current price July/August price $6.20 Portland
(Cash forward contract, Forward-to-Arrive Contract)
FUTURES + BASIS = CASH
A forward contract is a cash contract that allows a producer to sell grain for future delivery. Although both futures and basis are set, premium and discount scales may or may not be able to be set until delivery. An example of this contract would be selling new crop grain many months before harvest if market conditions lead you to believe that prices will be lower at that time.
- Easy, no complications.
- Locks in price, no downside risk.
- Can take advantage of a carry market.
- No service charge.
- Can defer income.
- Price locked in, can’t participate in a market rally.
- No payment until delivery
- May not be able to lock in premium or discount scales.
- Risk involved if production doesn’t meet expectations.
Minimum Price Contract:
FUTURES + BASIS (plus or minus COST / PROCEEDS OF OPTION) = CASH
Minimum price contracts are commonly used among producers as they are very simple to execute and have the least risk involved. The seller locks in his cash price, buys a call option to replace the amount of the sale, and delivers his grain. This strategy can be executed through your elevator or through a broker. The seller establishes the minimum price by subtracting the cost of the option from the cash sale price. He can choose to sell his option at any time before expiration, as long as it has value. Any premium that he collects from his option is then added to the original minimum price to arrive at the final selling price. Although a minimum price contract does not improve the final cash price in every case (option may expire worthless), the strategy reduces risk by eliminating the downside exposure. The advantage to a minimum price contract is that once the seller locks in his cash price, he is no longer exposed to adverse market movement. If the futures market moves higher after the cash sale, he can still participate in that move through the call option. The increase in value of the call will be added to his net selling price once he sells the call. The disadvantage of a minimum price contract is the seller can no longer take advantage of an increase in the basis since he has locked in the cash price, and the call only reacts to futures price movements. Also, time decay will erode the call’s value as it approaches its expiration date, which will partially offset increases in value due to rallies in the futures.
- No downside price risk.
- If futures rally, you receive increase in option value.
- Full payment (at established minimum price) is received when grain is delivered.
- Storage charges stop at the execution of the cash sale
- Can’t take advantage of basis appreciation.
- Cost of option can be expensive depending on length of expiration date and strike price used. Cheaper options need bigger rallies to return value above the price of the option.
- The value of an option does not move 1 for 1 with the futures market.
- If futures fail to strengthen, contract will expire worthless and the minimum price will be the final price.
- This contract can only be executed during trading hours (from 7:30 to 11:10 PST).
Current cash price $6.20, September Chicago $6.00 call $0.33/bu = $5.87 Minimum Price
(Basis Fix Contract)
FUTURES + BASIS = CASH
In this type of contract, the producer locks in a favorable basis with the elevator, leaving the futures price to be set later. Basis contracts are used successfully when the basis is a historically high levels and market conditions lead you to believe that there is room for improvement in futures prices. The delivery date and quantity will be determined at the time of the contract. Discounts and premiums are usually set at the time the Futures price is established, unless the sale is for new crop delivery.
If the deadline comes when you must lock in the futures price, but you want to leave the option open for further possible futures price increase, you may roll the basis contract into a deferred futures month. If the deferred futures market has a carry build into it (the deferred price is higher than the nearby price) your basis contract will be reduced by the amount of that carry. If the deferred futures market is in an inverse (the deferred price is lower than the nearby month), the amount of the inverse will be added to your basis contract.
- Eliminates downside basis risk.
- Can take advantage of potential futures price increase.
- By “rolling the basis” contract can remain unpriced for extended period of time, although if the futures months have a carry (i.e. Dec futures higher than Oct futures and Oct futures higher than Sept futures), then rolling the basis would decrease the basis by the amount of carry.
- Risk of futures price decrease.
- Required to deliver grain as stated in contract.
- Must track futures and market trends to lock in a favorable futures price.
Hedge to Arrive:
(Future Fixed Contract)
FUTURES + BASIS = CASH
A hedge-to-arrive contract allows the producer to lock in a futures price with the elevator, leaving the basis to be set at a later time. The elevator will establish a hedge in the futures on your behalf in exchange for delivery of the cash commodity at a set time. This contract is useful if futures prices are relatively high and market conditions lead you to believe that they will weaken and/or you think that there is room for improvement in basis levels. A hedge-to-arrive contract will be written for delivery of a specific amount of grain (usually 5,000 bu lots, but sometimes can be written for a smaller amount), a specific shipment period, and the set futures price. This contract will be complete when the producer sets the basis, which will determine the cash price. The basis can be set at any time but must be set prior to delivery and while the contracted futures month is still being used by traders to calculate cash price. (usually the 15th day of the month preceding contract expiration.)
- Limits downside futures price risk.
- Can take advantage of basis improvement
- No margin requirements to the farmer, since the elevator is carrying the position.
- May be allowed to roll the contract to a later month as long as the basis has not been set.
- Can’t participate in futures rally.
- Downside basis risk.
- Must monitor basis levels closely to lock them in when high.
- Locked into the elevator and required to deliver (unless allowed to buy back the contract)
- If grain is delivered prior to pricing basis, there may be storage charges
- This type of contract can only be executed during trading hours (7:30 to 11:10 PST)
Current Chicago Dec 2019 futures price $5.91 basis set at a later date and added to futures price to determine final cash price.
Platinum Contract: Forward contract cash grain and sell a call option.
Pros: Add call premium to cash price to receive a higher price than is available in the market. Can be used to start new crop hedging.
Cons: At expiration of the call option if the futures price is higher than the strike price then an HTA contract is written at that strike price. Results in additional bushels sold beyond initial cash sale at a lower price than the current market is trading.
Current cash price of $6.20, September 2020 Chicago $6.00 call option $0.33/bu = Cash price $6.53, if futures at option expiration 6/26/20 are above $6.00 then an HTA is written at $6.00 for Sept 2020.
Accumulator: HTA priced over a specific time period at a price that is above the current market.
Pros: Sell futures at a higher price than is currently available in the market.
Cons: Bushels sold accumulate over time so the final quantity sold is not known until contract is knocked out or entire time period is finished, many accumulators also have a double up component where if the accumulator runs to completion the quantity sold is doubled.
No Price Established
(NPE, Delayed or Deferred price Contract)
For this type of contract, the seller delivers and transfers ownership of his grain to an elevator without setting a sales price. No future or basis are established until the contract is priced. Because the title to the grain is passed to the elevator no storage can be charged but most times a service charge equal to the storage charge will be applied to the contract. Discounts and protein scales would usually be locked in when the contract is priced. We see these more and more as harvest space is getting tighter and tighter and many times an elevator cannot hold all the grain it is receiving. In order to move grain down the river to create more space the elevator has to have title to it.
- Allows the grain to be shipped immediately
- Can take advantage of futures and/or basis improvement.
- Allows you to defer income.
- It may be possible to change an NPE contract to a basis fix contract, thus stopping service charges and allowing you to receive an advance.
- No limit on downside price risk.
- Title of grain is transferred to the elevator
- No payment is made until contract is priced.
- May have to lock in discounts and protein scales.
- Service charges may apply.
Hedge-to-arrive contracts are a grain marketing alternative similar to forward contracting grain for future delivery, but rather than establishing a cash price, the producer establishes a fixed futures price in anticipation of basis levels strengthening prior to delivering and pricing the cash grain.
WHY USE A HEDGE-TO-ARRIVE (HTA) CONTRACT?
Producers looking to establish a new crop price for their production before delivery typically forward contract grain on the cash market for a future delivery period, establishing a fixed price with no opportunity for additional gains or losses. Under certain conditions, the difference between cash and futures prices may be small or “weak” by historical standards, presenting an opportunity to recognize gains from the basis strengthening.
Rather than sell and lock in a cash price for the grain, producers sell a futures contract through their grain company, establishing a fixed futures price that will protect from the market going lower, but allows for gains to the extent that the basis strengthens.
HOW DOES A HTA CONTRACT WORK?
Basis: The difference between a particular cash market price and chosen futures market. In the case of white wheat, it is determined by taking the current coast price and subtracting the futures price, which is normally a contract on the Chicago Board of Trade which represents soft red winter wheat prices.
Futures Month: The contract month chosen in the futures market which most closely matches the expected delivery time for the cash grain moving to the contracting grain company. Wheat futures trade in the months of March, May, July, September, and December.
Futures Contract Amount: 5,000 bushels per contract.
Delivery Period: Time frame established on HTA contract designating the month that grain is to be delivered to the contacting elevator company.
ESTABLISHING A HTA CONTRACT
Once a delivery period is determined, the producer chooses a contract month on the futures market closest to the expected cash grain delivery period, and instructs the contracting grain company as to what price and quantity to fix, or sell, the futures. The following hypothetical example illustrates how the hedge-to-arrive contact works:
Portland Cash Price (December 2015 $7.00
Chicago December 2015 Wheat Futures Price $6.76
Basis (Cash minus Futures) $+.24
I am using December 2015 in this scenario because it represents a basis level that would be closer to HTA expectations vs. 2014 December contacts which at this time are trading a fairly high basis historically. Under this scenario, the producer has an opportunity to sell Chicago December 15 futures at $6.76, at a plus .24 basis position which is determined by subtracting the futures price from the Portland coast cash price.
The producer instructs the grain company to fix or sell one December futures contract at $6.76 in anticipation of the basis level strengthening before setting the price for grain that will be delivered in November.
From this point forward, the producer will watch the difference between the December Cash price and the December futures to determine the basis, which will be added to the fixed futures price of $6.76 for the final December cash coast price.
RESULTS OF USING THE HTA CONTRACT
To illustrate the mechanics of using a HTA contract, results of both a rising and falling price scenario are shown below.
IF PRICES GO DOWN AND BASIS STRENGTHENS
Portland Cash Price (December) $6.50
Chicago December Wheat Futures Price $5.90
Basis (Cash minus Futures) $+.60
In this case, overall prices have gone down but the basis has strengthened, or gained 36 cents. The producer instructs the grain company to “lock in” the basis, which is added to the fixed futures price of $6.76 for a net coast price of $7.36, less any applicable off coast charges, storage and brokerage fees.
IF PRICES GO UP AND BASIS STRENGTHENS
Portland Cash Price (December) $7.50
Chicago December Wheat Futures Price $6.90
Basis (Cash minus Futures) $+.60
In this scenario, overall prices have gone up and the basis has strengthened or gained 60 cents. The producer instructs the grain company to “lock in” the basis, which is added to the fixed futures price of $6.76 for a net coast price of $7.36, less any applicable off coast charges, storage and brokerage fees.
Note that in both cases, basis was assumed to strengthen. If basis is negative at time of pricing, the loss is subtracted from the fixed futures price. Also, even with a strengthening basis in a rising market, HTA price did not keep up with the regular cash market.
BOTTOMLINE: Hedge-to Arrive contacts establish a floor price for the future delivery of cash grain and gains above the fixed futures price are limited to the amount of basis gain.