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Understanding Agricultural Futures John Hobert Farm Business Management Program Riverland Community College Chicago Board of Trade General Information Series: Introduction to Futures and Options Agricultural Futures for the Beginner Agricultural Options for the Beginner Buyers Guide to Managing Price Risk Cash Fundamentals What’s in a Price? Understanding Basis Chicago Board of Trade General Information Series Continued: Weather Markets Weather and the Corn Market Weather and the Soybean Market Weather and the Wheat Market Exploring the World of Ag Futures: The Chicago Board of Trade opened in 1848. CBT is the world’s leading futures exchange CBT offers a medium for businesses to offset risks of producing food and maintain price stability. The Market Participants: Hedgers Speculators Hedgers: Farmers Country Elevator Operators Processors Exporters Importers Speculators: General Public Floor Traders What Exactly are These Contracts Called Futures: “They are legally binding agreements, made through a futures exchange, to buy or sell commodities in the future.” “They are standardized in every way with the exception of price.” “They can protect individuals against dangerous price swings.” What Exactly are These Contracts Called Futures: “A futures contract is a firm commitment to deliver or to receive specified quantities and grades of a commodity during a designated month with price being determined by public auction(“outcry”) in the pit.” Using Futures Contracts to Help Your Business: To price stored grains. To price growing crops. To price feed grains. To gain market information. To speculate on $Price Change. To plan marketing programs. Elements of a Futures Contract: Quality Grade Price Delivery Point Time of Delivery Settlement of Futures Contracts: Offsetting your position in the futures market. Short Position: Go Long Long Position: Go Short Delivering your Commodity to the delivery point and meeting the other qualifications of the futures contract. The Costs of Futures Contracts: Commission fees for placing the contract. Basis change against your market position. Initial Margin money. Margin Calls to keep Margin at maintenance levels. Interest. Storage. Typical Margin Requirements: Grain Initial Initial Maint Req Cost/Bu Margin Cost/Bu Maint Corn $ .08 $400 $ .06 $300 Oats $ .05 $250 $ .04 $200 Soybns $ .12 $600 $ .09 $450 Typical Commission Fees: Grain Corn Contract Contract Size Commissions $22.00 5,000 Bu. Oats $18.00 5,000 Bu. Wheat $22.00 5,000 Bu. Soybeans $24.00 5,000 Bu. Carry or Carrying Charges: Futures Month Futures Price Carry Mar 98 274 May 98 282 8 Jul 98 288 1/4 6 3/4 Sep 98 288 1/4 0 Dec 98 288 1/2 l/4 Futures Market Jargon: Basis: The spread between cash and futures markets. Bull: An individual who thinks prices will rise. Bear: An individual who thinks prices will decline. More Futures Market Jargon: Cash Market: A place where actual commodities are bought and sold. Futures Market: A market where traders buy and sell futures contracts. Long: Buyer of futures contract. Short: Seller of futures contract. Future Contract Months Vary with Grain: Corn March May July September December Soybeans March May July August September November January Wheat March May July September December Futures Contract Quantities Vary with Produce: Corn, Oats, Soybeans 5,000 Bushels Wheat, Winter Wheat, 5000 Bushels Spring Wheat Soybean Meal 100 Tons Soybean Oil 60,000 Pounds Cattle, Hogs, Pork Bellies Feeder Cattle 40,000 Pounds 50,000 Pounds What determines Basis? It reflects transportation costs between your local market and the futures delivery point specified by the futures contract. It reflects the storage and handling costs until the delivery month of the futures contract. It reflects local supply and demand factors. Calculating Basis: A lower cash market(Spot) price minus a higher futures market price in a given contract month results in an “under” basis. i.e. 2.40 minus 2.70 = basis of .30 under A higher cash market(Spot) price minus a lower futures market price in a given contract month results in an “over” basis. i.e. 2.70 minus 2.40 = basis of .30 over The Long Hedge: (Buying) June-Cash Market Plans to purchase 5,000 Bu. Corn at $2.90 in August August-Cash Market Purchases 5,000 Bu. Corn at $3.40 in the Cash Market Futures Market Buys 1 CBOT Sept. Corn Futures Contract at $2.90 Futures Market Sells 1 CBOT Sept. Corn Futures Contract at $3.40 Long Hedge Example Result: Purchase price of Corn= Less futures gain = Net Purchase Price = In $3.40 .50 $2.90 this example, the farmer protected his corn purchase price by purchasing and selling a CBOT September Corn Contract. The Short Hedge: (Selling) May-Cash Market Plans to sell 5,000 bu. Corn at $2.60 in October Oct-Cash Market Sells 5,000 bu. Corn at $1.90 in the Cash Market Futures Market Sells 1 CBOT Dec. Corn Futures Contract at $2.60 Futures Market Buys 1 CBOT Dec. Corn Futures Contract at $1.90 Short Hedge Example Result: Sale Price of Cash Corn = Plus Futures Gain = Net Sale Price = In $1.90 .70 $2.60 this example, the farmer protected his corn sale price by selling and purchasing a CBOT December Corn Futures Contract. Corn Futures Problem 1: Cash Market Futures Market October Store at $2.44 June Sell at $2.19 October Sell July at $2.64 - .20 June Buy July at $2.24 - .05 .25 Loss .40 Gain Basis + .15 Corn Futures Problem 1 Result: Sale Price of Cash Corn = $2.19 Plus Futures Gain = .40 Net Sale Price = $2.59 In this example, the Farmer protected his stored grain by selling and purchasing a CBOT July Corn Futures Contract. How Predictable is the Futures Market? “The Futures Market does not always move as you might anticipate, but a hedger’s primary objective is to achieve price protection.” Soybean Futures Problem 2: Cash Market Futures Market October Sell at $6.35 November Price is $6.50 October Buy Nov at $6.35 + .00 November Sell Nov at $6.70 - .20 .15 Loss .35 Gain Basis + .20 Soybean Futures Problem 2 Result: Sale Price of Cash Corn = $6.35 Plus Futures Gain = .35 Net Sale Price = $6.70 In this example, the Farmer protected his purchase position by purchasing and selling a CBOT November Soybean Futures Contract. Soybean Futures Problem 3: Cash Market Futures Market May Buy at $7.00 November Price is $6.50 May Sell Nov at $7.00 + .00 November Buy Nov at $6.70 - .20 .50 Loss .30 Gain Basis - .20 Soybean Futures Problem 3 Result: Sale Price of Cash Corn = $7.00 Less Futures Gain = .30 Net Sale Price = $6.70 In this example, the Farmer protected his purchase position by selling and purchasing a CBOT November Soybean Futures Contract.