Using Futures

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Using Futures

• Commodity Marketing Activity
• Chapter 4

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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

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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

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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

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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

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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

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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

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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

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Hedges

• If Basis strengthens Cash2.30 Fut2.55
• 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, didnt see the profit
  when prices went up

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Long Hedge

• Same as short hedge for buying inputs
• Protection against prices rising
• Cant take advantage of a price decline

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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

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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
  wont cause you a problem
• you sell 4 wheat futures contracts
• What price can you expect?

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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

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Short Hedge Example

• Overall gain is 20,000 bu. Xs .25 cents 5,000
  better than cash price
• Pay commission of 80/contract

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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 _at_ 68.90
• Price you pay is 67 minus 2.90 gain in futures
  market 64.10

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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

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