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MINIMUM PRICE Contracts
FEATURES
* Immediate Delivery
* Futures Market Portion Priced Immediately Tied to a Strike Price Acting as a Price Floor
* Basis Priced Immediately
* Minimum Portion Received Immediately
DEFINITION
This alternative is a cash grain contract that calls for delivery of the grain to the buyer at a specific time. The contract will spell out a time period during which the seller can benefit if futures market prices move higher, thus looking in a higher price than the contracted minimum price. Similar to options on futures, 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 the ability to benefit if futures market prices move higher after the sale is made.
ADVANTAGES
* Allows the seller of grain the ability to benefit if futures market prices move higher. Normally this benefit is restricted to a certain time period.
* Provides a minimum price the seller of grain will receive in the event futures market prices decline prior to the final pricing of the contract.
* Allows the seller of grain the ability to capture favorable carrying charges when available without finalizing the pricing of the grain.
* Provides immediate payment for the cash grain. This payment is limited to the minimum price outlined in the contract.
DISADVANTAGES
* The minimum price that is guaranteed by the contract is normally a discount to prices that can be received if one simply sells the grain.
* Use of the contract does not allow the seller the flexibility to arbitrage markets at the time of shipment.
* Higher futures prices may not guarantee the seller an equally higher price than the minimum price quoted on the contract.
* The futures market may never increase enough to recover the premium spent.
EXAMPLE
On October 20th of the current year, FREMAR posts a cash bid of $2.00 per bushel for corn. You think the market will improve, but you don't want to pay storage or delayed price costs, and you also could use some money at the current time. You decide to enter a Minimum Price Contract with FREMAR and select a $2.50 strike price for July of the next year, which requires a premium of 18 cents per bushel. This contract allows you to lock in a minimum price of $1.82 per bushel. You may reprice the contract at any time between October 20 and June 21, the July option pricing deadline.
If the July futures price increases to $2.75 and the value of the call is currently 31 cents and you believe the market has peaked, you would instruct FREMAR to reprice your contract. In this case, the premium of 31 cents would be added to your minimum price and your total price would be $2.13. (1.82 + .31)
However, the market could have stayed steady or even dropped and your whole premium could be lost.
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