The emergence of complex grain marketing contracts, both over-the-counter products (e.g. accumulator contracts), and combinations of futures and vanilla options (e.g. price plus contracts), has complicated the management of farm portfolio risk. These new complex grain marketing contracts are often given unique names, and are unique in the way they manage risk.
We will compare a few of the attributes of the new generation contracts offered by firms including CHS, ADM, and Cargill. We also discuss other potential strategies that could accomplish similar risk management. It is critical to understand all details of an elevator contract, as subtle differences may exist between firms even though the contracts may seem similar.
Specific new generation marketing contracts we discuss here include: seasonal averaging contracts, premium contracts, minimum price contracts, and accumulator contracts. This contracts are compared in Table 1.
- Averaging contracts are typically just an average of the daily futures closes over a given time period to determine a contract price. One can accomplish the same result as averaging contracts by hedging a set amount of bushels equally during a specified period.
- There are also Averaging contracts that include downside price protection. These contracts are similar to buying a put and then selling a set amount of bushels each day—usually an equal amount.
- Premium contracts typically provide a premium to the futures price that is being offered today if in the future the producer is willing to sell more bushels if the futures price is higher than a target price that is set. Premium contracts usually only commit a set amount of bushels in the future sale, and if the price on a future date is below a target price then a sale of additional bushels is not required. Premium contracts are similar to selling an out of the money call and selling a futures contract.
- Minimum price contracts typically lock in a basis and a floor, but allow for some upside potential. This type of contract is similar to a basis contract to lock in basis, but also buying a put to ensure a minimum futures price.
- Another type of minimum price contract exists with limited upside potential but usually a higher minimum price. This would be similar to a basis contract plus buying a put and selling a call, or what is typically called a collar. The selling of the call returns a premium that can be used to help reduce the costs of buying the put.
- Finally, Accumulator contracts offer premiums on a non-guaranteed amount of bushels. In accumulator contracts, the bushels are committed and sold at a premium rate if the market does not fall below a threshold called a knockout barrier. Accumulator contracts also require a greater rate of bushels to be sold if the price rises above what is called the strike price or “double up”. The amount of bushels sold in an accumulator contract depends on the number of days the futures price remains above the knockout barrier and above or below the strike price. Accumulator contracts would be similar to buying an in the money vanilla put and selling out of the money vanilla calls. However, accumulator contracts are different in that the amount of bushels sold is dependent on the time and price path of the futures contract during the duration of the contract period. This difference typically allows higher premiums to be achieved but may involve less risk reduction.
- The also exists Accumulator contracts where a guaranteed amount of minimum bushels are to be sold. Bushels are committed and sold at a premium rate if the market does not fall below a threshold called a knockout barrier over the contact period. If the knock barrier is breached then the remaining bushels of the guaranteed amount of bushels are sold at the floor price.
|Table 1. Comparison of New Generation Agricultural Marketing Contract Across Firms.|
|ADM||Cargill||CHS||Producer Options||General Description|
|1.||Average SeasonalPrice (ASP™)||PaceSetter®||Similar to Selling a set amount of bushels each day for a given period.||Averages Daily Futures closes over a given time period to determine price.|
|2.||Price daily with floor||PaceSetter Ultra®||Foundation||Similar to Buying a Put and Selling a set amount of bushels each day.||Averages Daily Futures closes over a given time period coupled with downside protection to determine price.|
|3.||Bonus Offer®||Cash Plus||Similar to Selling a Call and Selling a Futures Contract.||Provides premium to the futures prices on today's sale with firm offer for future sale if futures finish above target at expiration, while bushels are null if futures finish below the target at expiration.|
|4.||Minimum Price Contract||PriceProtector® Put||Similar to Basis Contract plus Buying a Put.||Locks in basis and floor, allows for upside potential.|
|5.||PriceProtector® Call||Similar to Basis Contract plus Buying a Put and Selling a Call.||Locks in basis and floor, allows upside potential to ceiling.|
|6.||Price Accumulator™-Non-Guaranteed||Price Builder Bonus||Similar to Buying an in-the-money put and Selling out-of-the-money calls.||Premiums on a non-guaranteed amount of bushels, the bushels are committed and sold at a premium rate if the market does not fall below a threshold called a knockout barrier over a given period.|
|7.||Price Accumulator™--Guaranteed||Daily Price Plus Contract||Similar to buying an in-the-money put and selling out-of-money calls. Also, buying an out-of-money put to cover any unsold bushels at a floor price.||Bushels are committed and sold at a premium rate if the market does not fall below a threshold called a knockout barrier over the contract period. If the knock-out barrier is breached then any remaining bushels of the guaranteed bushes to be sold are sold at a floor price.|
There are positive and negatives of producers using elevator contracts versus performing the trades themselves.
- Positives: The positives are: producers can be provided an upfront payment for an agreed sale to the firm. Moreover, a producer would not have to maintain maintenance and margin in a futures/options trading account. Further, elevators can sometimes provide producers with unique risk management opportunities that would only be available by firms that offer over-the-counter products. Finally, contracting with elevators can give producers the opportunity to lock-in basis.
- Negatives: The negatives of utilizing contracts through elevators would be that they often result in committing your commodity delivery to a specific firm. Thus, opportunities to deliver to different locations that may offer better basis pricing at a future date are lost. In addition, an elevator may charge a greater fee on the contract than what you would have to pay in trading fees on your own. Finally, by contracting with an elevator, a producer exposes themselves to the specific financial risk of that firm, such as, default risk. Thus, it is important to know the financial health of an elevator you are considering contracting bushels to account for potential counter-party risk.
Trading on your own will typically require a producer to have a line of credit to manage maintenance and margin calls; however, interest costs may be less than having an elevator perform the trades where a set fee is included. Trading on your own may also give a producer greater flexibility when to execute trades and the type of risk management strategies a producer wants to utilize. Finally, when a producer performs their own trades or trades through a brokerage service, they do not limit their ability to deliver to a specific elevator in the future. This allows the producer to adjust delivery locations depending on pricing and other potential benefits.
This material is based upon work supported by USDA/NIFA under Award Number 2015-49200-24226.