Premium and Discount

A premium or discount is meaningless without the thing it adjusts from. This is the point most often skipped, and it makes reported adjustments impossible to interpret when it is. A discount for moisture is a deduction relative to some contractual moisture specification; change the specification and the same physical lot attracts a different discount, without anything about the lot or the market having changed at all.

The basis being adjusted from takes several forms, and which form applies determines how much discretion is involved and how predictable the adjustment is.

A contract schedule

Many contracts, including standardised exchange contracts, publish a table of premiums and discounts for stated deviations from the deliverable specification. Here the adjustment is mechanical: measure the deviation, read the table.

A grade standard

Where an official or industry grading system defines grades, the market prices grades relative to one another, and the adjustment follows from where the lot graded rather than from bilateral discussion.

A scheme requirement

Certification schemes may require a premium to be paid on certified transactions, in which case the adjustment is an obligation of the scheme rather than a market valuation of a difference.

Commercial negotiation

Where no schedule or standard covers the difference, the adjustment is whatever the parties agree. This is the most common case in differentiated and speciality markets, and the least predictable.

Attribution is the property that makes premiums and discounts analytically useful: because each adjustment names its cause, a price built from a basis plus several adjustments is decomposable. One can see what was paid for what. Neither a basis nor a spread offers this — both are single figures containing several influences that cannot be separated after the fact.

But attribution is a claim about the adjustment’s stated reason, not a guarantee that the reason is the whole cause. Where adjustments are negotiated rather than scheduled, the stated reason may carry weight that belongs elsewhere — a "quality discount" applied in a market where the seller has no alternative buyer is doing something other than pricing quality. The label is the parties’ description of the adjustment, and a description is not a proof.

• A scheduled adjustment is mechanical and verifiable against the schedule; a negotiated one is not
• Multiple adjustments may apply to one lot, and the order and base they are computed on affect the result
• An adjustment expressed as a proportion and one expressed as a fixed amount behave differently as the underlying price moves
• Where a lot deviates so far from the basis that no schedule covers it, the lot may not be deliverable at all — a discount cannot rescue material outside the specification
• The same named adjustment may be computed differently in different contracts; the name is not the method

Premium and discount are treated as one term because they are one mechanism operating in two directions from a common basis. A specification defines a standard, and lots fall on both sides of it. A schedule that pays for protein above a specification and deducts for protein below it is expressing a single valuation of protein, not two unrelated policies.

That symmetry is a design property of a schedule, however, and not a law of markets. Schedules are frequently asymmetric by intention: a deviation that costs a buyer real money to handle may attract a deduction larger than the addition an equivalent deviation in the other direction earns. Asymmetry is a commercial choice embedded in the schedule, and reading a schedule as though it must be symmetric will mislead.