Market Matters Blog

OMAHA (DTN) -- With new-crop December corn futures having rallied recently and then set back from the recent highs, it might be a good time to market some of your new-crop cash corn. The "bonus target" contract is a contract that has various names attached for each version of the same concept, depending on the cash grain company offering such a contract.

The contract is referred to as the Bonus Target contract at Bunge and Gavilon. At Cargill, it's called the Premium Offer, while ADM calls it the Price Max contract. Check with your local merchandiser to find more details on this or similar contracts.

In short, the bonus target is a contract where the producer agrees to sell one quantity of new-crop corn at the current market price and receives a bonus over the market price in return for a potential commitment to sell a second, like quantity, of corn if certain conditions are met. The second sale has a contingent pricing plan and does not always require delivery, but the bonus that is received upfront is always retained by the producer.

The cash delivery, or FOB grain price, is to be paid at the time of settlement of the initial sales quantity. The amount of the bonus received is determined by the producer's selection of a "target" futures price and target expiration. The expiration date, in the simplest form, will coincide with the CME exchange option expiration.

In a more complex version, an earlier expiration date could be used, but that would mean a lower bonus as "time value" is extracted from any premium or bonus received. The producer could also opt to use a more deferred delivery period as the target, adding to the amount of the bonus.

The futures price on the second (contingent)contract will never be higher than the target chosen. Delivery of the second sale is only required if, on the expiry, or target date, the underlying futures market (in this case December) is at or above the target strike price at expiration.

If the underlying futures price is below the target (strike price) on the expiration date, the producer has no further obligation to deliver that second quantity, but retains the upfront bonus, to be added to the cash price of the initial sale of corn.

The net effect is that the producer sells an initial quantity of new-crop corn at a value that is above the going cash market price and has a chance to sell a second quantity of corn at a value that is well above the current price.

These are contracts that are typically available to the farmer through a cash grain firm or local elevator in his/her area. The contract sounds a bit confusing and risky, but isn't really either, as long as the producer is satisfied with the first sale at the market, with a bonus over and above the cash market that equals the target "bonus" and is willing to complete a second sale only if the conditions above are met. The second sale is always higher than the initial sale. Since there is an option involved, the cash grain firm or the elevator will make the margin call on the sale of the option if needed. Assuming that the producer is willing to sell a first quantity, and prepared to sell a like quantity again if the market should rally to the target, there is no risk to the producer, other than basis, as we mention below.

EXAMPLE

Let's use an example, and to keep it simple, we'll say that a farmer typically produces 100,000 bushels of corn on his farm, and on irrigated ground (making forward marketing a bit less risky). The farmer is willing to sell 10% or 10,000 bushels at today's price. Let's assume December corn futures are at $4.75, and the delivered basis is 20 cents under December. That would be a cash-delivered price of $4.55 per bushel. The producer chooses a target of $5.10 futures as a place at which he would be willing to sell another 10% or 10,000 bushels. Today's option value for the $5.10 call is 19 cents. For simplicity, let's say the cash firm does not charge a fee for this contract. They would then sell two contracts (10,000 bushels) of the $5.10 December corn call. The producer would then receive the additional 19 cents over his initial cash sale of $4.55 delivered, changing the initial sale to $4.74 per bushel delivered.

So, the producer gets to sell the initial 10,000 bushels of new-crop corn at a price that is 19 cents higher than the local cash delivered bid. His obligation would then be to sell a second 10,000 bushels only if, on the expiration of December calls on Nov. 22, 2024, December futures is at or above $5.10 -- 35 cents above today's futures price. If the price is below $5.10 on that date, the producer has no obligation to sell that second quantity.

One issue could be that, unless the producer has an existing basis contract on the books to sell 10,000 bushels, there is basis risk between the date that the contract is booked and late November. The net impact of this example is that a producer could sell 10,000 bushels of new-crop corn for cash at 19 cents over market price, and if December is at or above $5.10 per bushel on Nov. 22, 2024, he would sell another 10,000 bushels at 35 cents higher, or $5.10 futures plus or minus the basis established.

Some of the benefits of using the bonus target (or a contract with a different name and same terms):

-- Producer captures a bonus above the market price.

-- Producer can select the target and expiration date.

-- Producer has a chance to receive a bonus on one sale and the chance to sell another like amount at well above the current market price.

-- It's a logical choice for the producer who sells at harvest and prices are depressed.

-- It can be attached to an existing basis contract.

-- There's no second obligation if the market is not above the target at expiry, but the bonus is kept.

A few disadvantages of using such a contract:

-- Futures on the second quantity can never exceed the "target" price.

-- It is possible that futures could exceed the target prior to expiration and then fall under the target, and the producer will not know if he is obligated on the second contract until expiry.

-- Without an existing basis contract, the basis on the second sale may not be determined until the expiration date.

-- Although the contract may sound confusing, it really is not, as long as the producer understands that he may have to sell another unit of grain if the "target" price is met or exceeded upon expiration.

CONCLUSION

We are currently in a situation in 2024 where the final corn production in Brazil is up in the air; and, with planting in the U.S. only 83% complete, we don't know what the final planted area will be in the U.S. However, with the potential for a comfortable 2 billion bushel-plus ending stocks, it may be time to book some new-crop corn. The bonus target contract allows the producer to sell at above market prices, with a contingent potential to sell a second quantity at well above the current market price, which is well above today's value.

Note: Prices used in the example above reflect option premiums as of May 31, and a hypothetical basis chosen by the writer. Ask your local cash grain company or elevator if they offer such a contract and what the economics are currently.

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Comments above are for educational purposes only and are not meant as specific trade recommendations. The buying and selling of commodities, futures or options involve substantial risk and are not suitable for everyone.

Dana Mantini can be reached at Dana.Mantini@DTN.com

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