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Focus: New Generation contracts provide marketing discipline

Agriculture.com Staff 10/16/2009 @ 1:36pm

Rising input costs and sliding commodity prices can make a marketing plan more critical than ever before. Developments in the financial markets and agribusiness have seen the evolution of what have been called "New Generation Grain Contracts."

These contracts are taking aim at the toughest marketing challenges with innovative strategies designed to supercharge the power of price averaging, automate sales, create more pricing alternatives, and expand the marketing window.

Origins of the New Contracts

One of the earliest examples of this"New Generation" was the Accumulator Contract. It proved extremely attractive when it was first offered at country elevators about seven years ago. Under the terms of the Accumulator, a farmer would commit to deliver an equal number of bushels on a regular basis, usually weekly, over a period of time. The contract offered an accumulation sales level above the current market price. As long as the CBOT closing prices stayed below the accumulation sales price, the farmer would be able to sell his weekly commitment of bushels from above the market.

The Accumulator has a floor called the"Knock Out" which is below the market price. If CBOT closing prices touch the Knock Out during the Accumulation period, the contract ends and the farmer keeps what payments he's collected up to that point. When the market is trading just above the Knock Out, the contract would be paying out the maximum for bushels priced at that time. The hedge risk is above the Accumulation sales price. If the CBOT closes above the contracted price, the farmer's delivery commitment is doubled, but still priced from the Accumulation sales level, which is then below where the CBOT is trading.

The basic model of the original Accumulator

For elevators, the Accumulator improves grain origination volume and efficiency. For farmers, the Accumulator's benefits are in how it imposes disciplined, consistent deliveries at a selling price that can look mighty attractive! However, that high price can tempt some farmers to commit too many bushels to the contract. If prices should rally, a farmer will be contractually obligated to deliver twice the number of bushels at the Accumulation sales price, while the market is trading above that level.

A New Kind of Contract

The original Accumulator contracts held positions above or below the market. How else could contracts be custom-tailored like this? OTC derivatives provided the answer. OTC derivatives transactions are counterparty to counterparty, two-way agreements, with specifications that can be customized. Trading these contracts requires opening an OTC account through an FCM and meeting minimum financial qualifications set by the CFTC. Of course, you must be a bona fide hedger. The FCM manages the margin requirements for positions.

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