Marketing contracts come in a lot of shapes and sizes. Here's a breakdown of the different varieties.
1. Futures hedge: Lets you use the futures market without involving a packer. You sell the lean-hog futures contract nearest the date when you expect to market the hogs. It doesn't eliminate future price risk or address market-access issues. You should only use futures with the support of a trusted broker and your lender.
2. Options hedge: Also a part of the futures market, but this time you buy the right to sell your futures contract at a certain price, called a put option. Put options tend to be expensive. They protect you against price declines, but don't limit the upside potential. You only pay for the premium, plus brokerage commissions.
3. Fixed price: These agreements determine the price of hogs for future delivery. They're short term, about one or two months, because as delivery time increases, so does the risk of establishing a fixed price. Ensures short-term plant access but not long term.
4. Fixed basis: You're offered the basis price – the difference between the cash price and futures price – instead of an actual exchange price. You're expected to fix a price relative to the futures market plus or minus the basis difference. These may run slightly longer than a year, but only ensure plant access during the life of the contract.
5. Formula price: Commonly used when you forward contract large numbers of hogs with a packer, but it's sometimes tough to establish a price. Formula prices don't provide price protection because they fluctuate according to the market. It may provide market access, but it's usually for quantities of hogs.
6. Cost plus: This is a formula price based on feed costs. It sets the minimum price level, making it a risk-protection contract, along with quantity assurance and market access. May range from four to seven years.
7. Price window: Similar to cost-plus contracts, but the pricing is different. You set a ceiling and a floor price. If prices fall between those two levels, you sell hogs at market price. If market price is above or below your set prices, you and your packer split the difference.
8. Price floor: Sets a minimum price. To compensate the packer for protection, you place a portion of the hog price above a predetermined ceiling level in an account to carry you through low price periods. If market prices are below your price floor, you can draw from this account.