Marketing Contracts
The following lists common contracts that are used by suppliers and end-users to market commodities.
Basis Contract
A basis contract allows marketers to specify or “lock in” the value of the basis or difference between the local cash price and the futures price for a commodity, delivered to a specific location, on a particular date. A basis contract is also known as a “Fix Price Later (FPL)” contract.1 This is because the futures price portion of the full delivered price remains open to fluctuate until its value is fixed either at or ahead of delivery.
Cash Contract
An agreement between suppliers and users of a physical commodity based on negotiated terms including quality, quantity, delivery time, and location. The prices of cash commodity market transactions are typically quoted for either “spot” or “forward” delivery, and hence, referred to as spot or forward contracts.
A spot cash contract involves a prompt or near term delivery of a commodity. The negotiated grade, quantity, and delivery, location are specified and price is set based off a relationship to the nearby futures contract, that is, the contract closest to expiration.
A forward cash contract calls for future delivery of a commodity. The negotiated grade, quantity, delivery location and time are specified and price is set based off a relationship to the appropriate deferred futures contract. This would represent the contract which would be the nearby month during the scheduled delivery period. In contrast to cash contracts, futures contracts are highly standardized with respect to quality, quantity, delivery time, and location. They are considered “benchmark” prices for the particular commodity because they represent the broad value at large, independent of local supply and demand factors.
Futures Contract
A contractual agreement, generally made on the trading floor of a futures exchange, to buy or sell a commodity at a pre-determined price in the future. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash.2
Option Contract
A contract that gives its owner the right, but not the obligation, to either buy or sell a commodity at a specified price, or strike price, for a specified period of time. There are two types:
- a call option contract gives its owner the right, but not the obligation, to buy a commodity at a price for a specified time.
- a put option contract gives its owner the right, but not the obligation, to sell a commodity at a price for a specified time.
Physical Contract
Physical contract is another way to describe a cash contract, or an agreement between suppliers and users for a physical commodity based on negotiated terms including quality, quantity, delivery time, and location.
Price + Basis Contract
Price + Basis contract is another way to describe a cash contract that emphasizes the two, distinct risk components within the contract: futures price and the basis price.
Price Only Contract
A price only contract is one that specifies quality, quantity, delivery time and location for the physical commodity and sets price relative to a specific futures contract, without committing to the basis price. This is also referred to as a “hedge to arrive” contract, as it is an agreement in the cash market between two counterparties to the futures price associated with the specific delivery period.
Window Contract
Window contract describes a class of cash contracts that set a minimum and maximum commodity price for the duration of the contract.
Sources: 1. United States Department of Agriculture Risk Management Agency. 2. University of Pennsylvania College of Agricultural Sciences.
