Different Types of Grain Contracts
Vital to success in any commodity market is knowing the options available to you and understanding the potential risks and benefits of each. In an industry like agricultural commodities trading, there is a wealth of information available with any simple google search. However, you must gather trusted, reliable data instead of getting lost for hours in conflicting charts and blogs.
DTN has the most up-to-date and accessible information for current and historical agricultural pricing and market options. That means you can find accurate market data specific to your crops whenever you need it.
DTN ProphetX is a valuable desktop and mobile app that provides you with an abundance of indispensable resources such as desktop trading, exclusive market information, trending charts, and deep USDA data.
With so many grain contract options available and ever-changing crop prices, how can you determine which approach is right for you? Which grain contract will effectively balance risk management without sacrificing potential profit increases? Are accumulator grain contracts conducive to your marketing plan, or is a more straightforward minimum price contract the way to go?
Before you can answer any of these questions, you need to be fully aware of the options available. Let’s examine the types of grain contracts and their potential risks and benefits.
What are the available grain contract types?
Also known as priced contracts, cash contracts are the most common, straightforward contract. A price is set for product delivery at an agreed-upon time; this can be immediate or at a deferred date. While this is a more straightforward option for a contract, you must stay up to date on all market pricing.
You determine the basis for delivery options in the contract. However, the futures price is left open with a basis contract. These contracts are beneficial when the basis levels are steady, but there is a potential for futures prices to improve. This flexibility can be very useful to farmers struggling with cash flow, as they can specify in the contract that they will receive a partial payment once grain is delivered.
Delayed price contract
Delayed price contracts allow for a large degree of adjustment over the course of a crop year. You determine the delivery period, but the final pricing is left open, set at a future date. However, it is important to note that there is frequently a service fee or monthly storage cost for unpriced grain.
These types of contracts rely on market data in establishing trends. An expected price improvement would make this an ideal arrangement. However, if it is a downward trending market, the unpriced grain could be a losing transaction.
Hedge-to-arrive or futures only contract
These types of contracts are advantageous when futures prices are at a peak. Every market crashes eventually, so this will allow you to take advantage of existing higher futures prices before the inevitable drop. You will define a future date in the contract for establishing a basis level and cash price.
Minimum price contract
Using a minimum price contract allows a farmer to take advantage of both a solid net flat price and a possible market increase. A guaranteed minimum price is established, but there is no limit on upward price enhancement, translating to no limit on expected profits.
Min/Max price contract
While similar to a minimum price contract, this option can be more profitable in the long run if a market trend increases gradually over the crop year, as opposed to swift fluctuations. There is a narrower window of risk in a Minimum/Maximum Price Contract than in a Minimum Price Contract. However, your potential profits will also be restricted.
Average price contract
Average price contracts can be useful for busy farmers who don’t have time to check grain bids each day. It allows you to price an equal number of bushels every day/week for the duration of a price season.
Accumulator contracts can allow you to price bushels above the market price when you double the number of bushels sold if the price exceeds the futures price. However, if the market prices stay low, there is a great deal of risk involved.
You establish a specific time period in this contract with two price targets – your selling price and your knockout price. The selling price is usually set above the market price, and the knockout price is set below.
Typically, these contracts are designed to sell bushels in small amounts, daily or weekly, until the end of the pricing period. These specifics allow bushels to be priced before triggering the knockout. During each specified time, one of three things will happen:
- The futures price is above the knockout price, and below the selling price, such that the specified bushels sell at the selling price.
- The futures price has dropped below the knockout price, and the contract is terminated, with any remaining bushels in the contract remaining unsold.
- The futures price has risen above the selling price, the bushels sell at the designated selling price stated in the contract, but the amount of grain sold doubles.
It is safest to limit the amount of grain designated for these accumulator contracts. You can usually only write these contracts for less than 5,000 bushels. This way, if a knockout does occur, there will only be a small portion of grain unsold.
Stay ahead of your competitors
As with any fluctuating commodity, grain market changes can be volatile and abrupt. Therefore, the reliable and timely analytics provided by services like DTN ProphetX give farmers a competitive advantage. Reliable analytics used to design a conversant marketing plan ensures you are fully prepared to undertake each new crop year. Learn more about how DTN can help you plan your next successful crop year.