Kent Beadle, director of producer brokerage for CHS Hedging, reviews the pros and cons of using alternative grain contracts in your marketing plan.
With so many grain contract options, how do growers know which ones are best for their businesses? Alternative grain contracts can present great opportunities, but don’t sign one without fully understanding the obligations.
“Alternative grain contracts are not unlike normal grain contracts, but they do specify delivery to a local elevator,” says Kent Beadle, director of producer brokerage for CHS Hedging. “They are hedged via over-the-counter mechanisms, which typically means there’s some amount of optionality involved in the pricing structure.”
That means there might be an average contract with some sort of a floor established, says Beadle, or it might mean there’s a premium paid for old crop bushels in exchange for an obligation for new crop bushels. “It could also mean that through option sales, a farmer would accumulate bushels over time at a price that’s higher than the actual market price but would take on obligations such as double-up requirements or knockout clauses.”
Pros and cons of alternative grain contracts
Alternative grain contracts can give you a higher price for your grain than you could get with a cash sale or hedge-to-arrive contract on the day you enter into the contract, says Beadle. These contracts can also provide you a floor and provide some upside similar to a put — usually at a lower cost than a put.
“One of the cons of an accumulator contract, for example, is the double-up requirement,” Beadle says. “If the market rallies up beyond a certain level, you’re going to owe the elevator twice as many bushels at that established price, which might cost you some opportunity. In the case of some of the premium-offer cash-plus contracts, where you are paid a premium for old crop grain and not for that obligation for new crop, your marketing can be hamstrung because you really don’t know if you’re going to have those obligations for additional bushels. That’s also a con for an accumulator contract.”
Comparing with using a brokerage account
Can an alternative grain contract be replicated with a brokerage account? Yes, but not exactly, says Beadle. “If you think about a floored average contract, purchasing a put does a good job of giving you a floor. If you buy a put, start averaging it into sales every week, and then start removing some of the puts, that would very effectively replicate that kind of product.”
“With accumulator-type contracts, often what you can do is sell grain to an elevator and then do a short straddle position in your brokerage account,” Beadle continues. “This also has the benefit of not giving you that double-up obligation, although it does effectively double up your marketing price with a rally at the amount of premium that you collect added to the strike price.”
Finding a place for alternative contracts
The bottom line, Beadle says, is that alternative grain contracts should generally play a small role in a grower’s marketing plan. “Generally, with contracts like the accumulator, which is one of the most popular contracts, we recommend only dedicating 20% to 30% of overall crop production. If growers truly understand the benefits and the obligations of these types of contracts, we think they have a place in marketing plans.”
This material has been prepared by a sales or trading employee of CHS Hedging, LLC, and should be considered a solicitation. There is a risk of loss when trading commodity futures and options.