Econ 339X, Spring 2010 ECON 339X: Agricultural Marketing Chad Hart Assistant Professor/Grain Markets Specialist

Econ 339X, Spring 2010 Today’s Topic HW #1, Contracting Grain, & New Generation Grain Contracts

Econ 339X, Spring 2010 Options Buy a put

Econ 339X, Spring 2010 Options Sell a put

Econ 339X, Spring 2010 Options Buy a call

Econ 339X, Spring 2010 Options Sell a call

Econ 339X, Spring 2010 Crop Insurance & ACRE 7. a) $3.90/bu * (75% * 200 bu/acre – 122 bu/acre) - $6.52/acre 7. b) 75% * 200 bu/acre *$4.20/bu – 122 bu/acre * $4.20/bu - $13.93/acre 8. a) ACRE Rev. Guar. = 90% * $3.83/bu * 171 bu/acre ACRE Farm Rev. Trigger = $3.83/bu * 171 bu/acre + $13.93/acre 8. b) Needed to check both triggers, but ACRE payment rate is based on state level revenues

Econ 339X, Spring 2010 Contracting  Basic Hedge-to-Arrive  Basis  Deferred Price  Minimum Price  New Generation  Automated Pricing  Managed Hedging  Combination

Econ 339X, Spring 2010 Hedge-to-Arrive  Allows producer to lock futures price, but leaves the basis open  Basis is determined at a later date, prior to delivery on the contract  So the producer still faces basis risk and production risk (must produce enough crop to cover the contract)  The buyer takes on the futures price risk

Econ 339X, Spring 2010 Hedge-to-Arrive  Why might you use it?  Think basis will strengthen before delivery  For the producer, the gain/loss on the contract is due to basis moves  Available in roll and non-roll varieties

Econ 339X, Spring 2010 Basis Contract  Also known as a “fix price later” contract  Allows producer to lock in basis level, but leaves futures price open  Producer still faces futures price risk and production risk  Buyer takes on basis risk

Econ 339X, Spring 2010 Basis Contract  Why might you use it?  Expect higher futures prices, but possibly weaker basis  Example  On July 1, producer sells 5,000 bushels of corn for November delivery at 20 cents under December futures.  On Nov. 1, Dec. futures set the futures price

Econ 339X, Spring 2010 Deferred Price Contract  Also known as “no price established” contract  Allows producer to deliver crop without setting sales price  Buyer takes delivery and charges fee for allowing price deferral  Producer still faces all price risk and production risk (if contract is set before delivery)

Econ 339X, Spring 2010 Deferred Price Contract  Producer also faces counterparty risk  If buyer files for bankruptcy, the producer becomes an unsecured creditor  Why would you use it?  Believe market prices are on the rise  Takes care of storage  Allows producer to lock prices at a later time  Producer benefits from higher prices and stronger basis, but risks lower prices and weaker basis

Econ 339X, Spring 2010 Minimum Price Contract  Allows producer to establish a minimum price in exchange for a service fee and the cost of an option  The final price is set later at the choice of the producer  If prices are below the minimum price, the producer gets the minimum price  If prices are above the minimum price, the producer captures a higher price

Econ 339X, Spring 2010 Minimum Price Contract  Removes downside price risk (below minimum price) and allows upside potential (after adjusting for fees)  Producer looking price increases to offset fees  Provides some predictability in pricing, can be set to be cash-flow needs

Econ 339X, Spring 2010 New Generation Contracts  Ever evolving set of contracts established to assist producers and users in marketing crops  Structured to overcome marketing challenges  Inability to follow through on marketings  Marketing decisions triggered by emotion  Complexities and costs of marketing tools

Econ 339X, Spring 2010 New Generation Contracts  Often broken into three categories  Automated pricing  Managed hedging  Combination contracts  Offered by several companies, each with its own twist on the contract  I will highlight some available contracts (for illustrative purposes only, not an endorsement

Econ 339X, Spring 2010 New Generation Contracts  The contract follow predetermined pricing rules  Often sold in set bushel increments, like futures and options, with a specified delivery period  Some have exit clauses (depending on price)

Econ 339X, Spring 2010 Automated Pricing  In its purest form, basically locks in an average price by marketing equal amounts of grain each period within a set time  Could be daily or weekly  Some contracts allow producers to pick the pricing period  Can be combined with other pricing approaches (minimum price, etc.)

Econ 339X, Spring 2010 Automated Pricing  Examples  Decision Commodities – Index Pricing  E-Markets – Market Index Forward  Cargill – PacerPro  CGB – Equalizer Classic  Variations  CGB – Equalizer Traditional  Cargill – PacerPro Ultra  E-Markets – Seasonal Index Forward

Econ 339X, Spring 2010 Automated Pricing Pricing period: Jan. to Mar on Nov soybean futures

Econ 339X, Spring 2010 Automated Pricing  Advantages  Automates marketing decision, frees up producer time  Removes concerns about additional costs (margin calls)  Can be set to capture average price when seasonal highs are usually hit

Econ 339X, Spring 2010 Managed Hedging  Automated contracts that implement pricing based on recommendations from market analysts  Example  Cargill – MarketPros  Producers can choose to follow CargillPros or Kluis Commodities recommendations

Econ 339X, Spring 2010 Managed Hedging  Has many of the same advantages as automated pricing  Results are dependent on the performance of the market analysts  Often has higher fees than automated pricing  Automated pricing: 3-5 cents/bushel  Managed hedging: cents/bushel

Econ 339X, Spring 2010 Combination Contracts  Extend or combine mechanisms from various contracts  Averaging pricing  Minimum pricing  Pricing based on market movements  Opt-out clauses if prices fall significantly  Come in many varieties, so producers can find one to fit their needs

Econ 339X, Spring 2010 Cargill – DiversiMax  Price is set by formula  75% of the price is determined by the average daily high futures price during a specified pricing period  25% of the price is determined by the highest price observed during the pricing period  Can be linked to a commitment to market additional grain (the commitment reduces the fee charged) Source:

Econ 339X, Spring 2010 Decision Commodities  Accelerator Pricing  Markets bushels when prices exceed a floor price, but marketed quantities depend on price level  For example, Source: If the Nov soybean price is Then we market < $8.000 bushels per day $8.00 to $ bushels per day $8.50 to $ bushels per day > $ bushels per day

Econ 339X, Spring 2010 Decision Commodities  Topper Pricing  Markets bushels when prices exceed a floor price on days where prices have jumped sharply  Example: Markets bushels when prices exceed $3.50/bushel on days where prices have increased by at least 15 cents/bushel  Takes immediate advantage of market rallies Source:

Econ 339X, Spring 2010 Decision Commodities Source:

Econ 339X, Spring 2010 Decision Commodities Source:

Econ 339X, Spring 2010 FC Stone  Accumulator Contract  Versions for producers and consumers  Key parameters:  Accumulator price – price grain is sold (or bought) at  Knockout price – price that terminates the contract  Weekly bushel sales commitment  Has acceleration function if price move beyond accumulator price Source:

Econ 339X, Spring 2010 FC Stone – Accumulator Source: Quantity marketed doubles Normal quantity marketed Contract ends

Econ 339X, Spring 2010 FC Stone – Consumer Accumulator Source: Quantity bought doubles Normal quantity bought Contract ends

Econ 339X, Spring 2010 Class web site: lawrence/ lawrence/