Basic Marketing Alternatives !!!!! Options on futures contracts open a whole new set of marketing tools that grain farmers can choose among and can provide a base to compare market trends against. Farmers need to use all the alternative tools to fine-tune their marketing programs. Too often reasonable pricing opportunities are passed by. The following will briefly describe marketing tools available and situations where you might want to use them.

Cash Sales You haul the grain to the elevator. You receive price buyer is paying on the day you deliver the grain.

Cash forward contract. You contract to deliver a specific number of bushels to the buyer during a pre-agreed time slot at a set cash price. You receive the agreed upon price when you deliver, no matter what the elevator is paying for cash grain when you deliver. When you forward cash contract, the buyer will generally turn right around and sell the grain to someone else to protect his elevation margin. He may sell futures, or he may forward cash contract with another cash grain merchant for delivery of your grain at a later date.

Price later contract You deliver grain to a buyer and transfer title of the grain to the buyer. The buyer gives you a certain amount of time to price your grain. When you elect to price it, you receive the price the elevator is paying for grain that day. These contracts are sometimes called delayed price contracts or no price established contacts. Buyers sometimes levy a service charge for your right to price it later. Grain buyers typically sell and deliver grain they purchase under delayed price contacts down the marketing channel. They use part of the money they receive for it as margin to buy futures to hedge their price risk. Elevators invest the rest of the money to earn interest. They attempt to calculate a delayed price service charge, which combined with interest earnings, will cover any basis improvement occurring between the time you deliver and the time you price. (basis risk, bankruptcy risk)

Delayed payment contract You deliver and set the price at the same time. You agree to receive payment later. The only difference from a cash sale is the time at which the buyer writes you the check. Delayed payment contracts are most often used when farmers want to price and deliver grain in one tax year, but want income in the following tax year. Farmers using both delayed price and delayed payment contracts are subject to financial risk should the buyer experience financial difficulties between the time you deliver and the time you elect to receive payment.

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Futures sale You sell a futures contract when the price is attractive as a temporary substitute for a cash grain sale you will make later. This is commonly called hedging. Cash prices at country points are generally lower than futures prices. The difference between cash and futures prices is called basis. To project the net cash price you can expect from a futures sale, you need to predict what the basis will be at the time you will buy back your futures position and sell cash grain. Subtracting the expected basis from the selling price of the futures contract you=d sell gives your expected cash price. If prices rise after you sell futures, you will end up with a futures loss. But cash prices should be rising. Subtracting your futures loss should still leave a net cash price near your expected cash price. Near is a key word. If basis is stronger (narrower) than you projected, your actual net cash price will be higher than expected. If basis is wider (weaker) than projected, actual net cash price will be lower than you expected. If you sell futures you have to put up margin money, you may get surprise margin calls and you will have to deal with a broker. Futures sales are much easier to get out of than cash forward contracts if you crop comes up short.

Basis contract You contract to sell grain to an elevator at a set basis relative to a specific futures contract. At most Corn Belt country locations your basis will be under the futures contract. If futures prices rise, you gain. If futures prices fall, you lose. Rise or fall, when you choose to price, the price will be the previously agreed basis relative to the current futures price. Again, generally the basis will be under futures. You=d use a basis contract if you expect prices to rise and basis to weaken. Most elevators will pay you a good chunk of your cash when you deliver, even if you wait until later to price your basis contract. As with a cash forward contract, the buyer will expect you to .

Hedge to arrive This contract works much like a futures sale, except the elevator sells the futures, pays the margin and gets the margin calls. Some elevators charge a fee for this service. If prices rise, you don=t share in the gain. If prices drop, you=re protected from the skid. However, you capture any basis improvement. You=d use a hedge to arrive contract if you expect prices to weaken and basis to improve. You can set the basis after you enter the contract, but before you actually deliver the grain. If you do, your hedge to arrive contract turns into a cash forward contract. A basis contract sets the basis. Your net price depends on futures price action. Under hedge to arrive, you set a futures price. Your net price depends on basis action. Considerably less variation generally occurs in basis than in futures prices.

Buy put option Buying a put option gives you the right, but no obligation, to sell specific futures contract at a preset price, known as the

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strike price, at any time you choose during the life of the option. For this right you pay a premium to the put option seller. Suppose prices rise after you buy a put. You can forget about your option, let it expire, and sell on the higher cash market. Suppose prices drop. One choice is to exercise your option into a futures position. You end up hedged at the option strike price. Another choice is to sell your option to someone else. You=ll collect a premium that is higher than the premium you paid. Either way, you capture about the same futures or option gain to add to your actual cash grain selling price. The right to share in price gains and be protected from falling markets does not come without price. That price is the premium you pay to buy the put option. The minimum price you establish by buying a put option is the futures strike price on the option you buy, minus expected basis, minus the premium, minus trading costs.

Minimum price contract Some elevators offer farmers the opportunity to set a minimum selling price, yet share in the gain if prices rise. Those are the same characteristics as buying put options. However, the farmer doesn’t deal with the brokerage firm. The elevator turns around and does the option trading legwork for the farmer.

Sell cash, buy future Suppose you like the basis, but not the price. You think prices will rise and you want to stop storage costs. Selling cash grain will stop your storage costs, and put cash in your pocket. You can turn around and buy an equal amount of futures. If prices fall, you=ll feed money into the futures market, rather than watching the value of stored grain drop. Sell cash, buy futures is a speculative strategy. But it=s no more speculative strategy than holding onto cash grain unpriced.

Sell cash, buy call Buying a call option gives you the right to buy futures at a preset strike price at anytime you choose during the life of the option. This differs from buying a put option, which gives you the right to sell futures. If you buy a call, you pay a premium to the call option seller. Sell cash, buy call has similar features to sell cash, buy futures. You can move out the grain, and retain an opportunity to share in a subsequent price rally. There are some key differences. You must pay a premium to buy a call. You need no premium to buy futures, but you must put up margin money to cover the futures contract. If prices drop after you sell cash, buy call, all you lose is your premium. If prices drop after you sell cash, buy futures, you keep paying margin calls.

Fence Suppose you like the idea of being able to set a minimum selling price and share the gain from a price rally as offered by buying a put option. But paying a big premium grates on your nerves. Options offer a strategy called a fence which may fit your needs. You buy a put option with a relatively low strike price. This establishes your minimum selling price, yet

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lets you share in upside gain. You also sell a call option with a relatively high strike price. You collect the premium. The premium you receive for selling the call will, at least partially, offset the premium you pay for the put, which holds net premium cost down. A couple of drawbacks exist. First, call option sellers are subject to margin requirements. More importantly, should prices rally above the strike price on the call option you sell you will be feeding money back into the market on your call option. This will cap your gain from the price rally. In some cases, a fence may be a good strategy. However, using it requires careful analysis of strike prices and premiums on options you choose to build your fence.File # 17.4 Marketing C:\doc\market\marketingtools.doc 9/99

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