Minimum Price Contract

The minimum price contract is probably one of the more common hedge instruments used by producers. For this type of contract, the producer sells his grain for cash the day of delivery. If the producer waited until harvest to sell his grain, his cash price would be $3.71 per bushel; he would then simultaneously buy a call option.

By selling the cash grain the producer has taken all of his downside risk out of the market. A floor has been established and the only risk a producer has is lost revenues if the market moves higher. By purchasing a call option, a producer can participate if there is an upside move in the market. Generally, a producer will likely pay between $0.10 - $.20 for an option that is fairly close to the money, depending on how much time he is purchasing. In this case, we assume the producer bought a call option for $.12.

By subtracting the price of the option from the cash sale, the producer establishes $3.51 as his minimum cash price. He also has a chance to enhance this price if and when he liquidates the call option. Options offer a limited risk way to stay in the market, as the only liability in owning an option is the premium. In other words, you will never lose more than what you paid for the option, even if the market continues to go down.