A forward cash contract is an agreement between a buyer and a seller for delivery of a specific amount of grain at a predetermined price at some future date.

Advantages:

• Lock in a price in advance,  eliminate price and basis risk.
• Simple, flexible and easy to understand.
• Deliver the crop upon harvest and eliminate the need to store the commodities.
• Cash contracts written for any quantity.
• Maintain title to grain until payment is received.

Disadvantages:

• Increased production risk.
• Cannot take advantage of rising prices (locked in price).
• Cannot benefit from strengthening basis.
• Usually involves a substantial penalty for failure to deliver.  (Most contracts are quite specific to the quantity, quality, place and time of delivery of the commodities.  A thorough understanding of the terms of the contract is necessary before signing.)

A futures fixed (Hedge To Arrive) contract is an agreement between a buyer and a seller for delivery of a specific amount of grain at a predetermined futures price at some future date.  The basis must be set between contract signing and contract delivery, at which point the final price is known.

Advantages:

• Lock in a price in advance, eliminate price risk.
• Simple, flexible and easy to understand.
• Deliver the crop upon harvest and eliminate the need to store the commodities.
• Maintain title to grain until payment is received.
• May be able to capture improved basis between signing the contract and delivery of commodities.

Disadvantages:

• Increased production and basis risk.
• Cannot take advantage of rising prices (locked in price).    
• Usually involves a substantial penalty for failure to deliver.
• Fee of 1 to 5 cents per bushel per contract.

Another fixed-price tool is an average price contract, which is an agreement between a buyer and a seller for delivery of a specific amount of grain at a predetermined date.  The price received will be the average of a certain number of weeks of that commodity’s price, collected once weekly. The basis must usually also be set between contract signing and contract delivery.

Advantages:

• Provides multiple pricing opportunities, usually during a time when positive price swings may occur
• Deliver the crop upon harvest and eliminate the need to store the commodities.
• Usually no fees, or very small fees.
• Maintain title to grain until payment is received.
• May be able to capture improved basis between signing contract and delivery
• Cash contracts written for any quantity.

Disadvantages:

• Increased production risk, as you have contracted to deliver the grain.
• Contains basis risk.
• Contains price risk, as the pricing period used is usually earlier in the year.  At-harvest market conditions may change and have led to higher prices.
• Usually involves a substantial penalty for failure to deliver.

Another tool is a minimum price contract, which is an agreement between a buyer and seller for a specific amount of grain to be delivered at a specific time. A minimum price is set for a small fee per bushel. The price is allowed to increase above the minimum price until the seller of grain “locks in” a price that gain will be delivered to the buyer. If the price goes below the minimum in the contract, the seller will receive the minimum price minus the fee. If a higher price is locked in, the seller receives the higher price, minus the fee.

Advantages:

• A minimum price contract allows you to lock in a minimum price and take advantage of any increase that may occur in the market.
• Deliver the crop upon harvest and eliminate the need to store the commodities.
• Maintain title to the grain until payment is made.
• Cash contracts written for any quantity of grain.

Disadvantages:

• Increased production risk, as you have contracted to deliver the grain.
• Contains basis risk.
• Usually a fee involved per bushel contracted    
• Usually involves a substantial fee for failure to deliver.

Another tool is a basis contract. A basis contract is similar to a forward cash contract, except only the basis is established.  Thus, the use of a basis contract does NOT set a price, only the basis portion of it.  This might be attractive if you expect the futures price to increase, but are concerned the basis could weaken.  You must lock in the futures price between signing the contract and grain delivery.

A basis contract is best for a situation where the harvest basis is historically strong but the futures price is believed to be capable of going higher.

Advantages:

• Eliminates basis risk
• Often receive a payment before final price is set

Disadvantages:

• Increases production risk before harvest
• Contains price risk

A basis contract is similar to a forward cash contract, except only the basis is established.  Thus, the use of a basis contract does NOT set a price, only the basis portion of it.  This might be attractive if you expect the futures price to increase, but are concerned the basis could weaken.  You must lock in the futures price between signing the contract and grain delivery.

A basis contract is best for a situation where the harvest basis is historically strong but the futures price is believed to be capable of going higher.

A margin account is an account set up with your broker to provide liquidity to your futures trades. If the market moves against your position, the margin account will provide money to cover your position. If your margin account runs out of money, you will get a margin call. A margin call is a request to deposit more money into your account. If your account runs out of money, your position will be exited and any gain or loss will be locked in at that point.

Your lender must be involved and knowledgeable of your trading plan. Many people have a line of credit with their lender for trading in the futures market.

“Stops” can be used to limit margin exposure. A stop is a sell or buy order at a given price in the futures market and the stop is triggered if the market moves to the level of the stop order.

Example:

You sell December corn futures in February for $4.59. In June the December corn contract is trading for $4.89. You have a $0.30 per bushel margin call or $1500. You have a margin line of credit with your lender so you cover the margin call. In November the December contract is trading for $3.89. You buy back the contract at $3.89, profiting $0.70 per bushel, or $3500. You receive your margin money of $1500 back as the futures price falls back to $4.59.

Below is an example of a margin account with an initial margin balance of $500 and a maintenance margin of $350.

You are free to sell the corn at any market or store the corn. Trading futures does not lock you into delivering to one market.  

All futures contracts have options associated with them.

A Put option is the right to force someone else to buy the underlying futures contract at a given price, the strike price. (Put onto them.)

A Call option is the right to force someone else to sell the underlying futures contract at a given price. (Call from them.)

Options do not have a margin account.

Your risk is the premium and commission involved in the purchase or sale of options.  The premiums paid to purchase these options fluctuate according to how close the strike prices are to the underlying futures contract price (real value), and how long before the option expires (time value).  Below is an example of premiums on options.

With this price tool, you are selling futures.  The following formula will provide an example of an expected price.

With this sale, you have a set sales price, but the basis is expected, not set.  Thus, you have an expected price, not absolutely set. You will buy the futures contract back at a lower price to exit the position.

Grain prices typically fall as harvest nears. The falling price allows you to purchase the contract back at a lower price than you sold it for.  This gain is added to your cash sale, ensuring or hedging your harvest price.

If the market price increases as harvest nears, you will lose money on your futures transaction and the loss will be deducted from your harvest price.

As with other marketing strategies, do not employ this strategy with 100% of your expected production.

Why doesn’t everyone sell futures (hedging)?

Advantages: 

• Average price is usually higher compared to forward contracting
• Not locked into delivery, can be rolled into a storage hedge to capture market carry after harvest

Disadvantages:

• Contract in units of 5,000 bushels
• Requires margin account and must provide margin money as market fluctuates (margin calls)
• Must buy futures to exit the position (unless you actually want to deliver grain to somewhere in Illinois)
• Basis risk
• Risk (small though it may be) of brokerage firm failure

Another option available is a forward contract and buy a call option.  For this soybean example, the forward contract price is $11.19, the Nov 2021 futures trading price is $11.89, with a $11.80 call (the right to buy at $11.80) and has a $0.90 premium.  What’s the minimum price?

If the futures price rises above $12.70 per bushel, you sell your option and add the profit to your cash forward contract price. $13.00 futures price – $11.80 option = $1.20 per bushel revenue – $0.90 premium = $0.30 profit. $10.28 minimum price + $0.30 profit from trade = $10.58 minimum price. Had the market price declined, you would have let the option expire worthless, or near worthless, and accepted the $10.28 forward contract price.

Let’s continue the soybean example using the buy a put option.  The Dec 2021 futures trading price is $11.89, with an $11.80 put (the right to sell at $11.80) and has an $0.84 premium.  What’s the minimum price? 

Clearly the cost of options creates a huge disincentive to use them as a trump card for lower price sales.

So what is the difference between buying a put option vs. forward contracting and buying a call option? 

Forward contracting and buying a call will fix the basis in the transaction.  This can be good if you like the strong basis implied by the forward contract.  Buying a put would make more sense if the new crop basis is wide, and you think the odds are good for a better basis by harvest.