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Hedging around different types of grain contracts

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Understand the risk associated with each type of contract and which tools are available to manage inherent price risk.

There are many different grain contracts that a producer can use depending on their bias, so I thought it would be useful to take a look at a few of them and how we advise hedging around them to manage risk.

Over the course of the marketing year, there are times when you might feel bearish on the futures price, but bullish on basis, or vice-versa. Sometimes the cash price offered looks like a great marketing opportunity and something to take advantage of.

Thankfully, there are a wide variety of different grain contracts available and strategies to manage the risk associated with each of them. We’ll examine a few of these contracts and how we advise hedging with put and call options to manage the risk associated with them.

Forward cash sales

A forward cash sale is made when the flat price is attractive to the producer. You are locking in the futures price and the basis and agreeing to the cash price that is offered. For example, the local grain elevator is offering $5.25 cash ($5.50 futures minus $.25 basis) and you decide to price some bushels at that price. The price risk in this scenario is if the futures price finds a reason to go higher.

You can defend a forward cash sale by buying call options in case the market rallies after you made the contract. This strategy eliminates downside risk on the contracted bushels and keeps you in the market, in case you sold too soon and the market works higher.

Hedge-to-arrive

Another commonly used contract is a Hedge-To-Arrive contract or sometimes called a futures only contract. A producer uses an HTA when they believe the futures price has peaked but feels the basis is not favorable (bearish futures, bullish basis). The HTA contract allows you to set the futures side of the price equation but leaves the basis to be established at a later date.

There is risk that the basis might not improve to benefit the producer, and that is a risk that cannot be hedged. However, we can manage the risk of the futures price working higher by defending the HTA contract buying call options.

Basis contract

A producer can use a basis contract if they feel the basis is very favorable, but they feel like the futures could go higher (bullish futures, bearish basis). In this scenario, the producer locks in the basis side of the price equation but leaves futures to be established before a pre-determined date in the future.

The risk of a basis contract is the futures working lower, thus giving the producer a lower cash price. At Advance Trading, we advise using basis contracts in conjunction with buying put options in order to defend lower futures prices. If the futures work lower, the put options will gain in value to offset a portion of the loss.

Delayed price contract

The last contract we’ll look at is Delayed Price contract, also called Price Later. A DP contract allows the producer to deliver the grain to their local grain elevator without establishing a price. Usually, but not always, there is a monthly cost for having the unpriced grain stored at the elevator; you need to take that into consideration.

The price risk associated with DP contracts is that the futures price works lower, so we advise defending those bushels using put options until the grain is priced.

Having a variety of different grain contracts in your marketing portfolio is pretty typical because our biases fluctuate throughout the marketing year. Therefore, it is important to understand the risk associated with each type of contract and which tools are available to manage the inherent price risk.

Contact Advance Trading at (800) 664-2321 or go to www.advance-trading.com.

Information provided may include opinions of the author and is subject to the following disclosures:
The risk of trading futures and options can be substantial. All information, publications, and material used and distributed by Advance Trading Inc. shall be construed as a solicitation. ATI does not maintain an independent research department as defined in CFTC Regulation 1.71. Information obtained from third-party sources is believed to be reliable, but its accuracy is not guaranteed by Advance Trading Inc. Past performance is not necessarily indicative of future results.

The opinions of the author are not necessarily those of Farm Futures or Farm Progress. 

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