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Hybrid contracts

Agriculture.com Staff 02/17/2006 @ 11:15am

I have been getting a lot of questions in the past couple of weeks about so called "hybrid" cash grain contracts. There is discussion on the 'Marketing' talk page about them also. Traditional cash contracts provide a set price for a given number of bushels of grain based on the futures price less basis. Contracts that are more complicated than the old standbys are nothing new.

Most of the unusual contracts that I have been questioned about involve some type of option transaction in addition to the normal futures hedge. There are so many of these contracts in use that it is impossible to describe all of them in a few words.

If an option sale is involved, there is a possibility that the seller might not know how many bushels of grain are committed until the end of the contract period. Selling a call usually means that bushels are committed if the price goes above the strike price. If it does not go above the strike price, then the bushels are not committed. The seller might have to deliver twice the bushels covered under the basic contract, therefore needing to have bushels in reserve just in case the price goes up.

The biggest concern that I have about unusual kinds of contracts is that the sellers do not understand them. From the number of questions I have fielded, it is obvious that farmers are somewhat confused about exactly what they are being offered. They certainly do not understand the risks involved.

One farmer commented that the premium being offered was just like an additional LDP. That is not the case. You cannot sell the bushels you collect the premium on until the end of the contract period. If the price goes down, you are left with grain that is worth less than you were hoping to get for it.

Ten years ago the grain market was in the middle of the hedge-to-arrive fiasco. The cause of this problem was elevators offering contracts that the farmers did not understand and the farmers committing to them in a big way. I wonder if we are about to see a repeat of this unfortunate scenario. Grain companies are anxious to offer incentives to tie up bushels because their business is based on handling large quantities of grain for a small margin per bushel. If you are thinking about entering into one of these contracts, be sure you understand it completely before you put your production on the line!

I have been getting a lot of questions in the past couple of weeks about so called "hybrid" cash grain contracts. There is discussion on the 'Marketing' talk page about them also. Traditional cash contracts provide a set price for a given number of bushels of grain based on the futures price less basis. Contracts that are more complicated than the old standbys are nothing new.

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