Description
This contract is intended to give the seller protection against
price drops but leaves final pricing until a later date. The
seller establishes a minimum price by paying the cost of an option
plus a service fee. The buyer generally adjusts the basis level
or futures level to reflect the cost of the option and fees.
Example: On April 1, a producer enters
into a minimum price contract for a specified quantity of corn
for November delivery. The minimum price is set at $2.15 per bushel
after deducting cash basis and fees. The final price will be
set later as requested by the producer, but no later than the
first day of the shipment period or expiration of the applicable
option contract, whichever occurs first -- in this case, November
1. The final price will be the minimum price of this contract
plus the value of a Chicago Board of Trade (CBOT) $2.60 call option on the date of pricing.
Risk to Seller
Although a minimum price contract does not improve final cash
price in every case, the strategy reduces risk by eliminating
downside price risk. The seller bears the risk that any price
increase may not be sufficient to offset up-front costs of the
option and fees. The seller also is subject to production risk;
that is, the producer is responsible for delivering the contracted
amount on the delivery date.
Risk to Buyer
On the contract date, the buyer assumes futures risk that
the final cash price locked in by the producer will exceed the
original futures price.
Who Might Use This Contract?
A producer who wants to lock in the predictability of a set
minimum price to help insure a certain income level or cash-flow,
but who wants to retain the ability to benefit from price increases.
Upside Price Potential. The producer stands to gain
from the increased value of the call in an up-trending market.
Downside Price Potential. Is not applicable; the producer is insulated
from any downside price risk by locking in a minimum cash price
on the contract date.
When Might This Contract Perform Well?
Generally, minimum price contracts will perform better from
the producer's perspective in a rising market. While the minimum
cash price is locked in on the contract date, the value of the
call will be greater if the futures price has risen, resulting
in greater gain for the producer.
When Might This Contract Perform Poorly?
By locking in a minimum price on the contract date, the producer
has insulation against a declining market. However, if the futures
price does decline following the contract date, the value of
the call is zero and the producer will not gain from an increased
value of the call.
Mention of product names or firms does not
necessarily constitute endorsement by the Risk Management Agency
or the U.S. Department of Agriculture over others not
mentioned, and is for information purposes only.
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