Basis Contract – allows the seller to lock in an acceptable basis offering on a specific quantity of grain. The pricing (futures) component of this contracting method, when used as a stand alone, is not initially specified and must be specified at a later date. An example: a farmer takes a basis contract at 20¢ over December for new-crop corn with the intent of fixing price later.

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Minimum Price Contract – allows the grain seller to lock in a minimum price and still have the opportunity to take advantage of higher prices that may occur later. The seller chooses a strike price, for which the grain dealer charges a fee (the option premium), and adds or subtracts the basis for the delivery month to determine the minimum sales price (MSP) offered. The futures price must rise above the strike price by more than the premium cost for the seller to achieve a selling price that is greater than what one could have gotten on a flat-price contract.

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Sell Cash, Buy Futures – The cash portion of this alternative is the same as that for the cash/spot sale. Buying the futures contract after making the cash sale is sometimes done to garner staying power in the market when a price increase over the storage period is expected and storage space is not readily available. Buying the futures contract is considered a speculative marketing alternative because the producer no longer has the grain to offset futures price changes, and a margin account is required.

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Sell Cash, Buy Call Option – The cash portion of this alternative is the same as that for the cash/spot sale. Buying the call option after making the cash sale is sometimes done to garner staying power in the market, particularly when a price increase over the storage period is expected and storage space is not readily available. Buying the call option is considered a speculative marketing alternative. Risk is limited to the premium paid for the call option.

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Sell Cash, Courage Call – sometimes advised for the purpose of making a cash sale in extremely uncertain times. An example, it is June 5th and December corn can be contracted for $2.70/bu. The weather situation is iffy, meaning price can go either way. The Dec $2.70 corn call has a 20¢ premium. The call is purchased for fear that the price could go up and the forward cash contract is taken at $2.70 per bushel. If price does go up in excess of the 20¢ premium then the seller will achieve a higher price from buying the call. If the price goes lower, then the net price received on the bushels contracted ends up being $2.50 per bushel ($2.70 - .20 premium for the call= $2.50).

In many cases, producers buy the call as early as the fall or winter before planting, when volatility is low and premiums are reasonable. It may be possible to limit cost to 8¢ to 12¢/bu.

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No-Price-Established Contract – This speculative contract is commonly used when on-farm storage facilities are not available. Physical storage fees apply, for example, 20¢/bu. from mid-October to mid-December plus an additional 4¢/bu./month thereafter.

It allows the seller to affix price and basis to the contract later, thereby taking advantage of the possibility of a higher price and/or an improving basis over time. This contract is very similar to a ‘store and wait' strategy being employed at home only without the quality risk involved in storing your own grain. Ownership of the grain transfers to the buyer once the NPE contract is entered into; the seller loses beneficial interest.

Note that by delivering and turning over ownership of the grain, the seller accepts payment risk and loses beneficial interest to the grain. If the buyer should default, such as filing for bankruptcy, the seller is an unsecured creditor. Some states provide some guarantees against this risk; others do not.

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Call Spread – (also called a bull spread ) includes buying a call option at one strike price and selling one at a higher strike price. Both options are for the same expiration month. A call spread is a less expensive alternative to simply buying a call. The income from selling the high-strike call offsets the cost of purchasing the low-strike call. It has limited upside potential because if prices hit the higher strike price where you sold a call, you must supply a long futures position (to the option buyer) by selling (in effect hedging your crop) .

For example, you might buy November $6 soybean calls, paying 62¢/bu. Then you sell $7 calls for 30¢. Your net cost—and money at risk—would be 32¢. If prices rise above $7 and your short call is exercised, you become hedged at $7 (but your $6 call and cash crop still gain in value). If you simply bought the $6 call, you would be out the 62¢ and would not net a profit until the market hit $6.62. In the case of the spread, between $6.32 and $7, you are better off since the premium cost is lower. In the event that the underlying futures price were to increase to over $7, just owning the call gives better results.


A call spread is long a call at one strike and short a call at a higher strike. Both options are for the same expiration. Call spreads are also called bull spreads.

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Store Grain, Long Cash Position – The grain marketer decides that the carry reflected in the storage months of the futures market is sufficient to risk storing grain without taking price risk protection. The grain and/or oilseeds being stored are in a long cash position because the grain marketer is speculating that the price will increase enough to pay carrying costs plus profit.

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Do Nothing – The decision to do nothing in terms of making a grain sale at any given point in time is a speculative marketing decision. Doing nothing could be specified in each quadrant of the decision aid. Doing nothing is a decision to wait on a better price, a better basis, or both before pulling the sales trigger. Caution: The decision to do nothing may result in unprofitable sales decisions. Basis and/or price improvement may not materialize. At other times, a decision to do nothing can result in a better price.

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Cash/Spot Sale – The cash sale, also known as the spot/daily to arrive contract, is the most common sales method used by farmers. The price of the spot sale is based on the nearby futures contract (+ or -) the basis and is stated as a cash price ($/bu., $/lb., or $/cwt.).

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Forward Cash Contract – Forward contracts are made for a specific price, quantity, and delivery date. The price of the forward cash contract is based upon the delivery month futures contract (+ or -) the basis and is stated as a cash price. The contract can be written to allow the seller to take payment at the time the grain is delivered or to defer payment until a later date.

Cash Sale for Deferred Payment – The cash sale for deferred payment – whether a spot sale or forward contract – is generally used for tax management, to defer income into the next tax year. Payment is taken in the tax year the seller chooses. Note that by delivering and turning over ownership of the grain, the seller accepts payment risk. If the buyer should default, such as filing for bankruptcy, the seller is an unsecured creditor. Some states provide some guarantee against this risk; others do not.

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Buy Put Option and Basis Contract – Buying a put option establishes a minimum sales price for a given amount of a commodity while retaining the opportunity to benefit from higher prices if they occur. The minimum price is known to the extent that basis may vary. Therefore, a basis contract can be assigned at any time prior to expiration of the put option in order to reduce or eliminate basis risk. In this quadrant, where basis is expected to worsen, it is used to lock in the favorable/strong basis.

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Sell Futures and Basis Contract – Selling a futures contract establishes price protection for an anticipated declining price during the production period. The hedged price is known to the extent that basis may vary. Therefore, a basis contract can be assigned at any time prior to expiration of the short futures position in order to eliminate basis risk.

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Season Average Price Contract – Offered in the cash market, the season average price contract allows the seller to contract bushels, agreeing to take an average price that is computed over a pre-determined period of time. For example, for corn the average price to be received is based upon the closing Chicago Board of Trade price every Thursday averaged from mid-March to the mid-July time period. For soybeans, the average price is computed from mid-May to mid-September

A basis contract is completed on the day that a Season Average Price Contract is entered.

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Sell/Write Covered Call Option and Basis Contract – The first portion of this marketing alternative is speculative in nature. The benefit to writing (selling) an option is that the seller keeps the premium. The risk is that if prices move to or past the strike price, the seller enters a futures position with its margin requirements. This can be handled in two ways - sell only at a strike price that results in a hedge that one can live with and/or buy back the option before it is exercised.

Covered Call: Covered means that one has the production or inventory equal to the number of bushels in the call. In the event the call is exercised, the seller is required to supply a long position to the option buyer, which means that you will go short (or sell the bushels in the futures market) – putting on a traditional hedge.

Example: A $2.50 corn call is sold for 10¢ when the underlying futures contract is trading at $2.30. There is a weather scare and prices begin rising. As they approach $2.50, the premium likely will also rise since there will be more chance the option will go “in the money”. As the call option seller, you have the choice of buying back the call, perhaps taking a small loss on the premium, and figure your cash grain will be worth more (offsetting the lost premium), or you can let the call be exercised, putting you into a short futures hedge at $2.50, a price you can live with.

A basis contract can be assigned at any time to eliminate basis risk.

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Hedge-to-Arrive Contract– In this cash contract the seller is allowed to lock in the futures price, removing the risk of a price decline, yet not risking margin calls if prices rise, and affix the basis before delivery. The HTA contract requires a specific quantity and quality of grain to be delivered to a specific location at a later date.

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Store Grain and Buy Put Option – Buying put options can be used to protect against declining prices and to allow for futures and/or basis improvement over time. Risk on the put option is limited to the price of the premium and does not require a margin account, but if prices decline, the put option will perform second best to hedging the stored grain, resulting in a price lower than if you had hedged, due to the premium cost.

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Store Grain and Sell Futures Contract (Storage Hedge) - Stored grain often should be hedged. A grain seller may decide to store grain rather than sell at harvest for two reasons – better prices offered in a deferred month and expectations that basis will be better later. A storage hedge can be used to allow capture of improving basis while providing protection against declining prices. Indicated net returns to the storage hedge can be computed up front. The only factor that can affect the indicated vs. actual return to the storage hedge is the ending basis. As for the futures transaction, a margin account must be maintained for the storage hedge.

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Option Window – Option windows are often used to lower the cost of buying a put option for downside price protection. The grain seller buys a put and writes a call to offset part of the cost of the put. This alternative is best used if one is slightly bullish and/or like the covered call, one can sell a call at a level where you wouldn't mind being hedged.

For example, you buy an at-the-money $2.20 December corn put because you think prices at harvest will drop to $2, giving you 20¢ value in your put. You pay 10¢, which would lower profit potential to 10¢. Now you sell a $2.40 call to bring in 8¢, lowering your put option cost to just 2¢ and raising potential put value to 18¢. If prices rise to $2.40, you face the same choice as described in ‘Write a Covered Call'.

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Put Spreads (also called bear spreads ) are constructed by buying a high strike price put and selling a low strike put. The payoff diagram shows that if the market hits the lower put that you sold, the put may be exercised and you would have to supply a short futures position, so you would enter a long futures position at that level. Note, as prices fall, the put you own would gain in value, offsetting the loss on the futures position. But also note that your cash grain would be falling in value as well.

Suppose you buy November $6 soybean puts for 46¢/bu. and sell $5 puts for 10¢—a net cost of 36¢. With a long put only, prices have to fall to $5.54 before you (break-even) but past that, you (profit) all the way down. Between $5 and $6, the spread provides more profit since you save 10¢ on premium cost. Because you become double long (your cash crop and a futures position) if the put you sold is exercised, this strategy is speculative.

A put spread is long a put at one strike and short a put at a lower strike. Both options are for the same expiration. Put spreads are also called bear spreads.

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Weak Basis

If the basis becomes less positive or more negative the basis is weakening. A weakening basis occurs when the cash price decreases relative to the futures price. Basis = Cash price - Futures price.

 

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Strong Basis

If basis becomes more positive or less negative the basis is said to be strengthening. A strengthening basis occurs when the cash price increases relative to the futures and the cash price is observed as becoming stronger relative to the futures. Basis = Cash price - Futures price .

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