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Understanding Minimum Price Contracts: A Guide for Grain Merchandisers

Understanding Minimum Price Contracts: A Guide for Grain Merchandisers

When offering Minimum Price Contracts (MPCs) as a marketing tool to farmers, it’s essential to clarify a key point: the elevator isn't buying call options for the farmer. Instead, the elevator buys the call option for itself to cover potential obligations. By doing this, the elevator secures a minimum price for the farmer’s grain and opens the door to benefiting from any rise in the futures market above a set price within a certain timeframe—for an agreed-upon fee.

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Breaking Down MPCs for Farmers

As a merchandiser, explaining the elements of the MPC contract clearly can prevent misunderstandings. The cash portion of the contract is locked in when the minimum price is established. At this point, the elevator buys the grain and sells futures. This action sets the basis for the elevator and a floor price for the farmer, making it identical to any typical cash grain transaction. Once the cash part is complete, the farmer should no longer be concerned with cash market fluctuations.

The upside potential comes from the call option the elevator buys to facilitate the MPC. The cost of this option is passed on to the producer, either through an invoice ahead of harvest or as a deduction from the grain settlement when the grain is delivered.

The Objective: “A Floor and Maybe More”

Often referred to as “a floor and maybe more,” MPCs guarantee a minimum price while offering potential future gains. Farmers, however, may focus too much on the “maybe more” part and downplay the value of the floor. As a merchandiser, it’s critical to emphasize the floor's value to reduce frustration down the road. MPCs should be viewed as price insurance rather than a way to chase market gains.

Some farmers may choose to self-insure by remaining in the cash market, using storage or delayed pricing (DP). When comparing DP or storage with MPC contracts, consider basis and any storage fees. The cost comparison may vary, and it’s important to focus on the value of the floor price and allow the farmer to choose their preferred approach.

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Re-pricing and Clear Communication

The re-pricing element of an MPC is crucial. The farmer should watch the futures market, not the cash market. Once a predetermined futures price is set, the producer can benefit from any increase above that price, penny for penny, with one opportunity to re-price. Keep your explanation simple—avoid technical option terminology like strike price, intrinsic value, or volatility. Instead, refer to the strike price as a base futures price and the option premium as a fee, making the contract more accessible to a wider audience.

Mechanics of MPC Contracts

  1. Buy the cash grain and sell futures in the relevant month, just like with a standard cash or forward contract.
  2. Offer the farmer various fee structures for setting a floor and staying in the market, with strike prices near the current market. If the farmer prefers, they can select a higher strike price for lower costs but a larger deductible.
  3. Ask the farmer for a target to re-price upfront. It’s easier for both parties to lock in a price when the producer has already made the decision to set a floor.
  4. When the farmer wants to capture an increase in the futures market, sell the appropriate number of futures contracts, in at least 1,000-bushel increments. The farmer doesn’t have to re-price the entire contract at once and can set targets for different quantities.
  5. At expiration, if the option has value, exercise it to receive a long futures position to offset any short futures.

MPCs are most popular with farmers who need a floor price or require money at harvest. Your ability to clearly explain the structure and benefits of these contracts can make a significant impact on their success with producers. By simplifying the details and emphasizing the value of price protection, you can offer MPCs as a valuable tool in a farmer’s marketing strategy.

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