A price floor is the minimum price a producer is willing to accept for his grain. It is set by taking some type of action in the market. That can be in cash or futures market. In a perfect world you’d set your price floor at cost of production plus reasonable return on your assets and investment. Example 5%.
How do I set a floor?
There are multiple ways to set a floor and be able to take advantage of an increase in the market. One is just to buy a put keeping in mind what you pay for the put. So, your floor for example is $5. You can buy a $5.20 put for $.20. Thus, setting the floor at $5. Buying a put at $5 that costs $.20 actually sets your floor at $4.80.
Another way is to set the futures and buy a call. Again, you need to keep in mind the amount you pay for the call. If you set futures at $5(your floor) but pay $.20 for the call, the floor is $4.80.
A less used option but still a viable option to set a floor and stay in the market is known as the min/max option. This would be selling an out of the money call and buying a put. For example, selling a $6.00 call for $.10, buying a $5.20 put for $.30. You pay $.20 for that position but gives you the floor at $5 and gives you the opportunity to capture the move to $5.80.
The examples we gave are just that examples. The market may not give you the option to hedge against a profit. You need a system that tells you when you need to protect yourself or outsource this risk to someone that can help you decide if that is in your best interest. Marketing is a process not an event. You can protect your downside even below profit levels and by staying in the market, you can enhance your positions to get the number to where you need to be.
