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Minimum Price Contracts: The Case for Choosing Shorter Periods of Time

Minimum Price Contracts: The Case for Choosing Shorter Periods of Time

When farmers enter into a Minimum Price Contract (MPC), they are essentially buying time — locking in today’s price while keeping the door open to benefit from potential price rallies during the contract period. Deciding how much time to buy is the biggest choice farmers are faced with when entering the contract.

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While the duration of market participation is a personal decision, there are distinct advantages to opting for shorter-term options over long-term ones, primarily in terms of cost savings and greater flexibility.

Truth is, you don’t have to buy all the time upfront. For instance, if a producer wants to stay in the market until June, it doesn’t mean he needs to buy a JUL option at harvest. Instead, he could purchase a shorter-term option and periodically reassess. If more time is needed, it can be purchased later. But there’s also the possibility that the extra time may not be necessary.

By purchasing a short-term option, such as a MAR option, instead of a JUL option, the producer can save on initial costs and have the flexibility to reassess their position as time passes. For example, let’s compare two producers who deliver grain at harvest in October and initiate an MPC on their bushels:

  • Producer A establishes a Base Futures Price against the MCH futures at $4.30 and pays 18¢ for a contract that expires on February 20.
  • Producer B chooses the JUL futures at $4.40, paying 28¢ for a contract that expires on June 20.

Both producers are positioned to benefit from any increase in futures prices, but Producer A and Producer B are using different time benchmarks. Let’s see how this plays out in two scenarios.

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Scenario 1: Prices Decline
If the futures price drops by 50¢ for both MCH and JUL contracts, Producer A has the chance to reevaluate his position in February. He can either let the contract expire or extend the contract by buying more time. Producer B, on the other hand, has no such flexibility and must wait for prices to recover to $4.40 before seeing any gain.

This gives Producer A a critical advantage: the ability to adjust to current market conditions. For instance, if JUL futures are now trading at $3.90, Producer A can set a new, lower Base Futures Price by extending his contract. There will be an additional cost to do so.  However, this puts him in a position to participate in any future price rally starting from a lower base of $3.90.

Producer B, in contrast, is locked into the $4.40 Base Futures Price and must wait for a market rebound just to break even.

Scenario 2: Prices Increase
Now, let’s consider a situation where prices rise. By February, MCH futures have climbed to $5.30, giving Producer A the opportunity to either price the contract and gain $1.00 (having spent less upfront), or extend the contract further. If Producer A extends by purchasing a new MPC based on JUL futures, they lock in the $1.00 gain and enter the new contract for an additional cost, such as 15¢. This results in a net gain of 85¢, with the possibility of further gains if the market continues to rise.

Producer B could also choose to price out their contract, roll up into a new JUL option, and achieve the same result. However, the difference lies in the motivation. Producer A, with an expiring contract, is compelled to take the profit and reinvest, whereas Producer B has the option to do so but might hesitate, potentially risking future gains if the market reverses.

Final Outcome
By the end of June, both producers might find themselves in similar positions, but Producer A had the advantage of flexibility to respond to market changes, whether prices rose or fell, giving him greater control over the outcome. Although Producer A may in the end spend a few extra cents in option costs to cover the same time frame as Producer B, the ability to adjust and reposition when necessary often proves to be the smarter choice.

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