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The objective in understanding and analyzing marketing alternatives is to find the alternative with the highest net return, the capacity to reduce income variability, and an acceptable level of risk.

Alternative methods are formed through combinations of when and how you market

• When – planting, pre-harvest, harvest, or post-harvest

• How – cash sale, deferred pricing, forward contract, basis contract, hedging with futures or options

Marketing methods discussed in this section: 

• Cash sale at Harvest

• Store for later sale

• Delayed pricing contract

• Forward contract

• Hedging with futures

• Basis contract

• Hedging with Options

Each section will discuss advantages and disadvantages of the marketing method, give insight as to when the method is most effective, offer real-life scenarios and give you the opportunity to personalize the method with your own farm example.
 

Advantages

• No costs or inconvenience of storage
• No accumulating interest costs
• Easily understood
• Price is known immediately
• No shrink or deterioration

Disadvantages

• Shortens marketing window
• Harvest price is often lowest
• Eliminates other cash-based alternatives
• Congestion at elevators

When to Use

• When prices are favorable and at levels anticipated in the marketing plan

Grain is placed in on-farm or commercial storage and sold at a later time determined by the grower.

Advantages

• Extends pricing decision window
• Increases flexibility with on-farm storage or increases delivery convenience with commercial storage
• Return on storage if price rises

Disadvantages

• Quality may deteriorate
• Decreased delivery flexibility if stored commercially
• Increased storage and interest costs
• Risk of adverse price change during storage

When to Use

• When prices are below the level anticipated in the marketing plan, assuming the producer has adequate financial resources
• When there is a realistic expectation of a market price increase

Advantages

• Extends pricing decision window
• Gain when prices rise
• May eliminate or reduce commercial storage fees (title usually passes to elevator upon delivery)
• Possible advance payment
• Convenient contract quantities

Disadvantages

• Interest costs and storage fees
• Unsecured creditor in bankruptcy
• Rise of adverse price or basis change until grain is priced
• Potential repayment of part of the advance if price drops

When to Use

• When storage is tight
• When unsatisfied with current prices and local elevator wants to move more grain into the marketing channel

Grower agrees to deliver a specified quantity and quality of grain to the buyer, at a designated place and date, and at a pre-determined prcie.

Advantages

• Contract quantity can be small allowing for 'spreading' sales throughout the season.
• Easy to initiate and little or no costs to sign a contract
• Eliminates risk of adverse price or basis change
• Extends pricing decision window

Disadvantages

• Guarantees a fixed price, no gain if price raises or basis strengthens
• Increases production risk as delivery is an obligation
• Reduces flexibility when market conditions change

When to Use

• To schedule deliveries that better fit with labor, grain quality and logistics
• When crops are large or storage is tight
• When the market price reaches the objective in the marketing plan
• If price and basis are both considered acceptable.

Advantages

• Extends pricing decision window
• Risk of adverse price change is eliminated
• Easy to reverse position
• Basis is more predictable than price

Disadvantages

• Risk of adverse basis change
• Margin requirements increase interest costs and may cause cash flow problems
• Contracts only offered in fixed increments
• Requires knowledge of futures and basis
• Eliminates gain from rising cash price

When to Use

• To protect the value of grain in inventory or  the value of expected production
• To help reduce downside price risk
• When price is acceptable and basis is unacceptable??? And hope basis improves

Date:  Mid January

Expected production:  30,000 bu of wheat in August

Sell date:  Approximately 15-Aug

Appropriate futures contract month is Sep

Evaluate expected hedge price using CBOT Sep futures contract:

Sep futures price            =  $3.35/bu

+ expected local basis   =  ($.10)

- cost of hedging            =   $.02            

= expected hedge price =  $3.23 cents

Compare hedge to other alternatives

• Cash forward contract

• Price with options

• Don't Price

Decision price with hedge:

• Quantity to hedge:  67% of production (~20,000 bu)

• Number of contracts: four (20,000/5,000)

• Sell four Sep contracts at $3.35

• Expected hedge price = $3.23/bu

Grain is delivered to a commercial elevator and sold prior to a designated date at a specified amount about or below a futures price (or basis).

Advantages

• Extends pricing decision window
• May reduce commercial storage costs
• No risk of adverse basis change
• Convenient contract quantities
• Possible advance partial payment

Disadvantages

• Unsecured creditor in bankruptcy
• Risk of adverse price change until grain is priced
• Potential repayment of advance
• Basis knowledge is required

When to Use

• When basis is strong (cash prices are high relative to futures) and there is some potential for an increase in futures prices
• When basis offer is acceptable but price is unacceptable???

Advantages

• Extends pricing decision window
• May reduce commercial storage costs
• No risk of adverse basis change
• Convenient contract quantities
• Possible advance partial payment

Disadvantages

• Risk of adverse basis change
• Cost may be greater than value of price protection
• Contracts in fixed quantities only
• Requires significant knowledge and substantial data

When to Use

• When you need to eliminate downside price risk but want to maintain ability to capture possible upside price gains

A put option that allows the holder to take a futures position is purchased for the actual or expected cash position.

• Options can be exercised, sold, or allowed to expire
• Net price received is a combination of the cash market and options market transactions

Date:  January 15

Objective:  Evaluate price protection available through harvest (August)
 

Current futures/options market situation:

            CBOT Sep wheat futures price = $3.35 per bushel

We know:

• Have ability to purchase “right to sell” (put option) CBOT Sep futures

• Have right to sell at several different strike prices above or below the current market price

• Premiums vary by strike price; right to sell increases in price as strike price increases

• Option on Sep wheat expires Aug 25

Option premium influenced by:

• Strike price relative to the current futures; intrinsic value exists if strike price is above futures price

• $3.00 put has 0 cents of intrinsic value

• $3.40 put has 5 cents of intrinsic value

• Time until expiration; futures price can change

• $3.00 put can have intrinsic value if futures price goes below $3.00

• More time to expiration = more time value

• More market volatility = more time value

Closing a put position

• “Sell” at the current premium; premium changes over time as futures price changes and expiration approaches

• Let option expire if worthless; option expires with no intrinsic value

• Exercise and obtain futures position; may be automatic if expires with value

EXAMPLE 1

Date:  January 15

Objective:  Expects to harvest 30,000 bushels of wheat in August

1. Evaluate expected price protection
   Strike price of Sep put                =          3.30
   + expected local basis               =          (.10)
   - put cost (premium + fee)           =          .28
   = Expected price protection        =          2.92
    

2. Decision to buy
   a.       Quantity to protect:  67% of production = 20,000 bushels
   b.       Number of contracts:  4 (= 20,000/5,000)
    

3. Buy put options
   a.       Four CBOT 3.30 Sep wheat put options at $.28 (= $.27 premium + $.01 broker fee)
   b.       Expected minimum price = $2.92/bu with potential to benefit if price increases

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