ECON 337:
Agricultural Marketing
Lee Schulz
Assistant Professor
lschulz@iastate.edu
515-294-3356
Chad Hart
Associate Professor
chart@iastate.edu
515-294-9911
Short Hedgers
Producers with a commodity to sell at
some point in the future
Are hurt by a price decline
Sell the futures contract initially
Buy the futures contract (offset) when they
sell the physical commodity
Short Hedge Example
 A soybean producer will have 25,000 bushels
to sell in November
 The short hedge is to protect the producer
from falling prices between now and
November
 Since the farmer is producing the soybeans,
they are considered long in soybeans
Short Hedge Example
 To create an equal and opposite position, the
producer would sell 5 November soybean
futures contracts
Each contract is for 5,000 bushels
The farmer would short the futures, opposite their
long from production
 As prices increase (decline), the futures
position loses (gains) value
Short Hedge Expected Price
 Expected price =
Futures prices when I place the hedge
+ Expected basis at delivery
– Broker commission
Short Hedge Example
 As of Jan. 16,
Nov. 2015 soybean futures
Historical basis for Nov.
Rough commission on trade
Expected price
($ per bushel)
$ 9.76
$-0.30
$-0.01
$ 9.45
 Come November, the producer is ready to sell
soybeans
 Prices could be higher or lower
 Basis could be narrower or wider than the historical
average
Prices Went Up, Hist. Basis
 In November, buy back futures at $10.50 per
bushel
Nov. 2015 soybean futures
Actual basis for Nov.
Local cash price
Net value from futures
($ per bushel)
$10.50
$-0.30
$10.20
$-0.75
($9.76 - $10.50 - $0.01)
Net price
$ 9.45
Prices Went Down, Hist. Basis
 In November, buy back futures at $8.00 per
bushel
Nov. 2015 soybean futures
Actual basis for Nov.
Local cash price
Net value from futures
($ per bushel)
$ 8.00
$-0.30
$ 7.70
$ 1.75
($9.76 - $8.00 - $0.01)
Net price
$ 9.45
Short Hedge Graph
Hedging Nov. 2015 Soybeans @ $9.76
Prices Went Down, Basis Change
 In November, buy back futures at $8.00 per
bushel
Nov. 2015 soybean futures
Actual basis for Nov.
Local cash price
Net value from futures
($ per bushel)
$ 8.00
$-0.10
$ 7.90
$ 1.75
($9.76 - $8.00 - $0.01)
Net price
 Basis narrowed, net price improved
$ 9.65
Long Hedgers
Processors or feeders that plan to buy a
commodity in the future
Are hurt by a price increase
Buy the futures initially
Sell the futures contract (offset) when they
buy the physical commodity
Long Hedge Example
 An ethanol plant will buy 50,000 bushels of
corn in December
 The long hedge is to protect the ethanol plant
from rising corn prices between now and
December
 Since the plant is using the corn, they are
considered short in corn
Long Hedge Example
 To create an equal and opposite position, the
plant manager would buy 10 December corn
futures contracts
Each contract is for 5,000 bushels
The plant manager would long the futures,
opposite their short from usage
 As prices increase (decline), the futures
position gains (loses) value
Long Hedge Expected Price
 Expected price =
Futures prices when I place the hedge
+ Expected basis at delivery
+ Broker commission
Long Hedge Example
 As of Jan. 16,
Dec. 2015 corn futures
Historical basis for Dec.
Rough commission on trade
Expected local net price
($ per bushel)
$ 4.15
$ -0.25
$+0.01
$ 3.91
 Come December, the plant manager is ready to
buy corn to process into ethanol
 Prices could be higher or lower
 Basis could be narrower or wider than the historical
average
Prices Went Up, Hist. Basis
 In December, sell back futures at $5.00 per
bushel
Dec. 2015 corn futures
Actual basis for Dec.
Local cash price
Less net value from futures
-($5.00 - $4.15 - $0.01)
Net cost of corn
($ per bushel)
$ 5.00
$-0.25
$ 4.75
$-0.84
$ 3.91
 Futures gained in value, reducing net cost of
corn to the plant
Prices Went Down, Hist. Basis
 In December, sell back futures at $3.00 per
bushel
Dec. 2015 corn futures
Actual basis for Dec.
Local cash price
Less net value from futures
-($3.00 - $4.15 - $0.01)
Net cost of corn
($ per bushel)
$ 3.00
$ -0.25
$ 2.75
$+1.16
$ 3.91
 Futures lost value, increasing net cost of corn
Long Hedge Graph
Hedging Dec. 2015 Corn @ $4.15
Prices Went Down, Basis Change
 In December, sell back futures at $3.00 per
bushel
Dec. 2014 corn futures
Actual basis for Dec.
Local cash price
Less net value from futures
-($3.00 - $4.15 - $0.01)
Net cost of corn
($ per bushel)
$ 3.00
$ -0.10
$ 2.90
$+1.16
$ 4.06
 Basis narrowed, net cost of corn increased
Hedging Results
 In a hedge the net price will differ from expected
price only by the amount that the actual basis differs
from the expected basis.
 So basis estimation is critical to successful hedging.
 Narrowing basis, good for short hedgers, bad for
long hedgers
 Widening basis, bad for short hedgers, good for long
hedgers
Class web site:
http://www.econ.iastate.edu/~chart/Classes/econ337/
Spring2015/
Have a great weekend!