As corn producers look to capitalize on the recent 90-cent rally in December corn futures from the mid-May contract low, one notable cash contract stands out. I know the contract as a "bonus target," which is a moniker I created while at DeBruce Grain in Kansas City. It may also be known as a "premium offer" contract.
In this contract, a farmer decides to capitalize on the recent rally by selling some of his anticipated production on new-crop corn. Suppose he is one of the lucky ones who planted corn in a timely fashion and feels comfortable forward selling some of the corn, even though there may be more upside in store.
Here is how the bonus target contract could work:
As recently priced, the farmer sees December corn futures at $4.43 and the new-crop basis from the local cash grain elevator is 35 cents under December futures. Let's say the farmer has 5,000 bushels of new-crop corn to sell. The net cash price of $4.08 delivered to the elevator is enticing when compared to the mid-May price of $3.29. However, the producer would like to get a $4.25 cash price for his new-crop. The local grain merchant suggests that there is a way to receive $4.25, but it entails the potential for a commitment to sell another, similar-quantity, of new-crop corn during harvest time. That contract is the bonus target.
Following the example, the farmer makes a commitment to sell 5,000 more bushels of new-crop corn at $5.00 for a net cash price of $4.65 a bushel. The local grain firm is willing to sell a $5.00 December call option for 19 cents and assumes the risk for any margin requirement. In this example, the firm takes 2 cents of the option premium and gives the farmer a "bonus" of 17 cents. That brings the net cash price of the farmer's first sale to $4.25 ($4.08 plus 17 cents).
What's the catch? In return for the 17-cent "bonus," the producer promises to sell and deliver another 5,000 bushels of new-crop corn if December corn is above the $5.00 option strike (or target) price on Nov. 22, the day the option expires.
The producer can establish both the target price and the expiration given several choices. In our example, the target is $5.00, and the expiration is Nov. 22, 2019. Even though options are involved, the farmer never has to worry about meeting margin calls -- that is the responsibility of the cash grain firm. The farmer never sells options or futures.
The net effect of this strategy is that the farmer receives a 17-cent per bushel bonus or premium above the local cash price and has the potential to sell another 5,000 bushels at a price that is 57 cents per bushel higher than December corn was at contract inception.
Before choosing this kind of contract, you will want to carefully examine the terms and conditions at your local grain firm.
Here are some disadvantages to consider:
-- Until the option expires on Nov. 22, there is no guarantee the second sale will be made.
-- The futures price of corn can exceed the target prior to expiration and fall back below later, in which case a second sale is not guaranteed.
-- Basis can change at any time and one may want to consider a separate contract to lock in basis.
-- The futures price on the second sale will never be higher than the target chosen at inception.
Also, it's important to keep in mind that no more than 20% to 25% of new-crop production should be committed to the bonus target in the event that futures go much higher.
So, in conclusion, if you have seen a sharp rally in corn and would like to sell some corn -- either old-crop or new-crop; if you feel confident in your production, and if you would like to get a bonus above the current market price and have a chance to sell new-crop corn at a price level that is well above the current price, a bonus target contract could be for you. However, although you feel that prices could work higher, there is also bearish risk to consider. There is a lot of growing season ahead and increased export competition from South America.
The bonus target could be helpful to your marketing plan, if you understand the benefits and costs. Check with your local grain merchant to see if such a contract is available.
Comments above are for educational purposes and are not meant to be specific trade recommendations. The buying and selling of grains and grain futures involve substantial risk and are not suitable for everyone.
Dana Mantini can be reached at firstname.lastname@example.org
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