Using Futures

Commodity Marketing Activity

Chapter #4

What is a Futures Contract?

Standardized agreement to buy or sell a commodity at a date in the future

Commodity to be delivered Quantity Quality Delivery Point Delivery Date

Futures As the delivery month approaches,

futures price tend to fall in line with cash market prices

Anyone may buy or sell futures through brokers

Obligation to take delivery on a purchased contract is removed by sell before delivery (Offsetting)

Visa Versa

Hedging

Buying or selling futures contracts as protection against the risk of loss due to changing prices in cash market

Protection against falling wheat market or rising feed cost

Short Hedge: plan to sell a commodity Long Hedge: plan to buy a commodity

What is Basis?

Relationship between local cash market and futures market price

Basis = cash $ - futures $ a negative number is under a positive number is over

Short Hedge Corn Dec. Forward cash market is $2.30 Dec. Future price is $2.55 Basis is 25 cents under Sell Dec. Corn Future In Dec. Corn market price is $2.00,

Futures price is $2.25 (25 cents under) buy back futures contract at $2.25, sell

corn for $2.00

Short Hedge

Sell Future $2.55 Buy Future $2.25 Profit =

$0.30

Dec Forward $2.30 Dec Cash $2.00 Loss = $0.30

You get $2.00 on cash market plus $.30 from futures = $2.30

What if prices go up?

Sell Future $2.55 Buy Future $2.90 Loss =

$0.35

Dec Forward $2.30 Dec Cash $2.65 Profit = $0.35

You get $2.65 on cash market minus $.35 from futures = $2.30

Hedges If Basis strengthens: Cash=2.30 Fut=2.55

Basis Future $ Cash $ Fut Gn Net

-.15 2.25 2.10 .30 2.40

-.10 2.25 2.15 .30 2.45

-.15 2.90 2.75 -.35 2.40

-.10 2.90 2.80 -.35 2.45 Protected when price fell, didn’t see the profit

when prices went up

Long Hedge

Same as short hedge for buying inputs Protection against prices rising Can’t take advantage of a price decline

Margin Exchange clearing house requires you

make a deposit to guarantee possible losses

If prices change significantly, you may have to deposit more money

Contract obligation is Offset when you buy or sell back

Commission charged by brokers for trading contracts

Short Hedge Example:

Sept. you plant winter wheat and expect a 20,000 bu crop

you feel that prices are headed down $500 per contract margin deposit and

commission won’t cause you a problem you sell 4 wheat futures contracts What price can you expect?

Short Hedge Example: July futures price is $3.60, forward cash

price is $3.33 (27 cents under) based on experience, you expect basis to

be about 16 cents under In July, futures price falls to $3.35, cash

price to $3.20 (15 cents under) you buy back 4 futures contracts at $3.35

(25 cent gain) sell wheat at $3.20 and get $3.45

Short Hedge Example:

Overall gain is 20,000 bu. X’s .25 cents = $5,000 better than cash price

Pay commission of $80/contract

Long Hedge Example: You plant to buy 120 head of feeder cattle

in March In Dec. indications are that prices will rise You buy 2 feeder cattle futures (88,000#)

at $66/cwt Futures price goes up to $68.90 in Mar.,

and cash price is $67 You sell back futures contracts @ $68.90 Price you pay is $67 minus $2.90 gain in

futures market = $64.10

Long Hedge Example:

You have reduced your cost by $2,552 from the cash price

minus commission of $75 /contract should have a definite plan should have a target price