Minimum Price Contract using a Put Option
This alternative is a cash grain contract that calls for delivery of grain at a specific time. The contract will set a timeframe which the seller can benefit if the futures market price moves lower than the contracted price. The basic premise of the contract is that it allows the seller of grain the ability to sell grain at a specific minimum price, but also affords the seller to benefit if futures market prices move lower after the sale is made.
- Provides a minimum price to the seller with the opportunity to gain on the price if the futures market moves lower before the contract’s expiration date.
- Allows the seller the ability to capture favorable carries when available without finalizing the price of the grain.
- Provides immediate payment for the cash grain upon delivery. The payment is limited to minimum price outlined in the contract.
Example: On June 1, Fremar is posting a new crop cash bid of $6.20. You think the market will move lower between now and harvest, and decide enter a minimum price contract by using a put option. You select a December $6.00 put option for 35 cents and it expires November 23rd. Your minimum price contract with Fremar is $5.85 (6.20-.35). On November 1st, December futures have fallen to $5.50 and the premium on your put is now worth 65 cents. You instruct Fremar to re-price your contract, and your final price is $6.50 (5.85+.65). You deliver new crop bushels in November to fill the contract.
- The minimum price that is guaranteed by the contract is a discount to prices that can be received if one simply sells cash grain.
- Lower futures prices may not guarantee the seller an equally higher price than the minimum price quoted on the contract.
- The futures market may never decrease enough to recover the premium spent.