Hedging
Hedging
Hedging in the futures market can be an important component in a producer’s price risk
management toolbox. However, even for producers who never hedge directly in the futures
market, understanding the mechanics behind a futures hedge, and how to calculate the expected
net selling or buying price resulting from a hedge can be important information in analyzing the
quality of any cash market selling or buying opportunity.
A futures market hedge involves taking a position in the futures market as a temporary substitute
for a transaction that will occur in the cash market at a later date. As long as the futures and cash
markets move together, any loss in one market will be offset by a gain in the other market, and
the net transaction price incurred at the end of the hedge period will equal the price that was
expected when the hedge was set.
The key element in arriving at an accurate cash price expectation resulting from a futures market
hedge is having an accurate basis forecast. Hedging is essentially the trading of price risk for
basis risk. The more accurately the basis is forecast, the closer the final transactions price will be
to the price anticipated when the hedge was placed.
Short Hedge or Hedging a sales price
A producer who expects to sell something in the cash market later can protect the future cash
market price by selling a futures contract for the identical commodity now. This is also called as
a short hedge. When the initial trade is the sale of a futures contract, the seller is said to be
“short”, in the market. The seller has sold a commitment to make delivery of a commodity. For
example, if a producer expects to sell corn next November, he/she could sell a December1 corn
futures contract. Each contract is for 5000 bushels of corn,2 so in many cases a futures hedge
will not correspond to the exact same number of bushels that are to be sold in the cash market.
Once a futures hedge has been initiated, the producer has exchanged market price risk for basis
risk. Recall from Chapter 2 that basis risk is the risk that the futures and cash prices do not end
up with the same relationship that was initially anticipated. If the basis ends up weaker than
expected (i.e., the cash price is lower relative to futures than anticipated), the producer’s actual
net selling price will be lower than thought when the hedge was initiated. If the basis is stronger
than expected (cash price higher relative to futures than initially anticipated), the net selling price
will be higher than originally thought. The only thing that can affect the final outcome of a
hedged position is a change in basis relative to expected basis.
1
For most commodities, there are not futures contracts for delivery every month. In grain markets, producers
should hedge with the futures contract that specifies delivery as close to, but after, the cash transaction is expected to
take place. There is a November corn contract, but it will expire before the end of November, thus the December
contract would be the best choice to hedge a November cash sale.
2
There are also contracts for corn (and other grains) in 1000-bushel amounts traded at the Mid-American Futures
Exchange in Chicago. They can be used for hedging, but most futures brokers do not discount their commissions for
the smaller volume contracts, so per bushel transactions costs tend to be higher than with the full size contracts.
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Hedging
Assume it is May 1, and a grain producer is considering hedging 15,000 bushels of soybeans for
October delivery; i.e., the producer wants to deliver soybeans into the cash market at harvest, but
wants to lock in the harvest price in May (recall that 5000 bushels is equal to one futures
contract). To calculate the expected price from the hedged position, the producer must note the
current futures price for the November soybean futures contract.3 This futures price must then be
"localized", or translated into an expected local cash price. This is done by adjusting the futures
price by the basis. The relevant basis is the one the producer thinks will exist in October (i.e.,
the October cash soybean price minus the November soybean futures contract price), not the
basis which exists on May 1.
If the producer has paid close attention to previous years’ basis relationships in the October
delivery period, he/she will be in a position to derive an accurate estimate of the expected price
resulting from a hedge for October delivery of soybeans.
Suppose on May 1 the November soybean futures contract is trading for $6.50 per bushel. Based
on pervious experience, the producer expects basis in October to be minus $0.40. In other words
the producer’s cash soybean price in October is expected to be $0.40 below the November
soybean futures price in October. The producer would expect to receive a selling price of $6.10
per bushel soybeans in October if a hedge were initiated on May 1. This comes from a May 1
futures price for November soybeans of $6.50 localized by the negative $0.40 basis. However,
to initiate a hedge the producer must work with a futures broker. The producer will have to pay
the broker a commission to initiate the futures position, and deposit the initial margin required
for the position in a futures trading account (recall the discussion of futures margins from
Chapter 1). Assume the commission is $50 per contract, or $0.01 per bushel for a 5000-bushel
contract. Then the net price the producer expects to receive for cash soybeans in October is
$6.09 per bushel. This comes from adjusting the expected cash price of $6.10 per bushel for the
1 cent per bushel broker’s commission. As long as the basis forecast is accurate, the producer
can be confident he/she will receive $6.09 per bushel regardless of what happens to soybean
prices between May and October.
Example 1 illustrates the hedge described above. Note the producer nets $6.09 per bushel for
soybeans in October regardless of whether prices rise or fall over the hedge period. This is based
on the assumption that the basis expectation is realized at the end of the hedge period. In other
words there is no change in basis i.e. the basis remained constant from the time the hedge was
initiated to the time that the hedge was lifted.
3
This is the soybean futures contract that expires closest to, but after the expected cash sale date.
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Example 1. Short Hedge or Hedging a Sales Price.
Assume it is May 1, and a grain farmer wants to protect the price received for October harvested
soybeans. November soybean futures contracts are trading for $6.50 per bushel. The farmer
would hedge harvest soybean prices by selling November futures on May 1. Adjusting the May
1 futures price for the expected basis in October, and the futures broker’s commission derive the
expected cash price in October.
Date
Futures Market
Cash Market
Basis
May 1
Grain farmer sells 3
November soybean futures
contracts
Establishes an expected
October selling price of
$6.50 + (-$0.40) - $.015
(Futures + Basis - Comm.) =
$6.09
Expected to be
$6.50
-$0.40
Scenario 1. Perfect Hedge (Declining prices): Assume the November futures contract is $5.50
when the cash sale is made in October, and basis turns out as expected. The producer sells the
cash soybeans for $5.10 per bushel (futures is $5.50 and the basis is -$0.40). He then buys the
November futures contract he sold on May 1 back for $5.50 per bushel. The basis was
accurately forecast, and his net selling price is as expected.
Date
Futures Market
Cash Market
October
Grain farmer buys 3 November
futures contracts for $5.50 per
bushel.
Sells 15,000 bushels of
soybeans to the local coop
Sold on May 1 $6.50
Bought on Oct. 1 $5.50
+Cash price
$5.10
Futures profit +$ 0.99
-------
Futures profit
$1.00/bu.
Broker’s comm. - $0.01//bu
-----Net Futures Profit $0.99/bu.
Basis
-$0.40
(No change in
basis)
Net Selling Price $6.09
The combination of a cash price of $5.10/bu. plus a futures profit of $0.99/ bushel. nets the grain
producer an effective soybean price of $6.09/bu., which is what was expected. This is a perfect
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hedge because the expected basis is same as the final basis. The basis remained constant.
Observe that the hedge gave protection from downside price risk.
Scenario 2. Perfect Hedge (Raising prices): Assume the November futures contract is $7.50
when the cash sale is made in October, and basis turns out as expected. The producer sells the
cash soybeans for $7.10 per bushel (futures is $7.50 and the basis is -$0.40). He then buys the
November futures contract he sold on May 1 back for $7.50 per bushel. The basis was
accurately forecast, and his net selling price is as expected.
Date
Futures Market
Cash Market
Basis
October
Grain farmer buys 3 November
futures contracts for $5.50 per
bushel.
Sells 15,000 bushels of
soybeans to the local coop
Sold on May 1 $6.50
Bought on Oct. 1 $7.50
+Cash price
Futures loss
-$0.40
$7.10
-$ 1.01
-------
(No change in
basis)
Futures loss
$1.00/bu.
Broker’s comm. - $0.01//bu
-----Net Futures Loss -$1.01/bu.
Net Selling Price $6.09
The combination of a cash price of $7.50/bu. minus a futures loss of $1.01 nets the grain
producer an effective soybean price of $6.09 /bushel, which is what was expected. Observe that
there is no change in the basis estimated and the final basis. Also realize that in the case of rising
prices the hedge prevented the farmer from taking advantage of rising prices.
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Scenario 3. Imperfect Hedge (Basis risk: Weakening basis): This is the same as scenario 1,
except in this case the basis turns out to be weaker than expected by $0.10/bu. A weaker basis
means that the cash price is lower relative to futures than had been expected. The expected basis
is minus $0.10 where as the actual basis is minus $0.50. If the basis is weaker by 10 cents, the
cash price is 10 cents lower than would have been the case if the basis forecast had been correct.
Date
Futures Market
Cash Market
October
Grain farmer buys 3
November futures contracts
for $5.50 per bushel.
Sells 15,000 bushels of
soybeans to the local coop
Sold on May 1
$6.50
Bought on Oct. 1 $5.50
+Cash price
$5.00
Futures profit +$ 0.99
-------
Basis
-$0.50
(10 cents weaker
than expected)
Futures profit
$1.00/bu.
Broker’s comm.- $0.01//bu
-----Net Futures Profit $0.99/bu. Net Selling Price $5.99
While the futures hedge did protect the cash position from most of the price decline, the
unexpected weakening of the basis did result in a lower net sales price than originally
anticipated. Observe that even though this hedge was able to prevent the price risk but there was
basis risk. For a short hedger weakening basis results in lower net selling price.
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Scenario 4. Imperfect Hedge (Basis risk: Strengthening basis): This is similar to scenario 3,
except that the basis ends up stronger than expected. A stronger than expected basis means that
the cash price is higher relative to the soybean futures price than had been originally anticipated.
Date
Futures Market
Cash Market
November
1997
Grain farmer buys 3
November futures contracts
for $5.50 per bushel.
Sells 15,000 bushels of
soybeans to the local coop
Basis
-$0.30
Sold on May 1
$6.50
Bought on Oct. 1 $5.50
Futures profit
$1.00/bu.
Broker’s comm.- $0.01//bu
-----Net Futures Profit $0.99/bu.
+Cash price
$5.20
Futures profit +$ 0.99
-------
(10 cents stronger
than expected)
Net Selling Price $6.19
This time the producer ends up better off then expected as the result of a stronger basis. Futures
prices over the hedge period fell by more than cash prices resulting in a stronger than expected
cash market. In the case of rising prices (such as in scenario 2), cash price would have to raise
more than futures prices for the basis to strengthen. For a short hedger strengthening basis results
in higher net selling price.
Conclusion
The net selling price of a hedged cash commodity will not change regardless of
whether prices rise or fall over the hedge period as long as the basis is accurately forecast.
Once a commodity is hedged, price risk has been traded for basis risk. It is critical to have as
accurate an expectation of basis as possible in order to minimize the possibility of receiving a
net selling price that is less than the expected selling price.
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In scenario 3 and 4 where there is basis risk and the outcome (net selling price) differed from that
of perfect hedge scenarios given in 1 and 2. Scenarios 3 and 4 in example 1 show what happens
to a hedged position when the basis forecast is wrong. If the basis turns out to be weaker than
expected,4 the producer will get a lower net selling price than originally anticipated (scenario 3).
However, if the basis turns out to be stronger than expected, the producer will get a higher price
than anticipated when the hedge was placed (scenario 4).
Scenarios 3 and 4 illustrate the need for accurate basis forecasts in developing a
Successful hedging program. Recall that a hedge effectively trades price risk for basis risk. As
long as changes in basis levels are smaller than changes in price levels, a hedge contains less
market risk than an un-hedged position. However, to absolutely minimize market risk it is
critical to accurately anticipate the basis.
A template for calculating the expected return from a selling hedge is presented in table 1. All
costs incurred in facilitating the hedge activity result in decreasing the effective price received by
the seller for the final commodity. To compute the estimated price of a commodity protected
through a hedge, the hedger takes the futures price, adjusts it for the basis, and then subtracts the
futures broker’s commission.
Table 1. Template for Calculating Expected Net Selling Price from a Short Hedge.
Futures Price
_________________
+ Expected Basis
_________________
- Brokers Commission
__________________
__________________________________________
= Expected Net Selling Price
__________________________________________
4
A weaker than expected basis would occur if the cash price is lower relative to futures than originally
anticipated. A stronger than expected basis is one in which the cash price is higher relative to the futures
price than was anticipated. For example, if a producer expects the basis to be +$1.40 (meaning the cash
price will be $1.40 above the futures price at the end of the hedge period), but the basis is actually +$1.35,
the basis is 5 cents weaker than expected. If the cash price turns out to be more than $1.40 above the
futures price then the basis is stronger than expected.
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Hedging
Trading Mechanics:
In addition to accurate basis expectations, a successful hedger must be able to finance the futures
part of the hedge over the hedge period. Futures contracts are traded on margin. This means
both buyers and sellers of futures contracts must post an amount of money with their futures
broker as an insurance bond against defaulting on any loses that may be generated in the futures
account. This deposit is called as initial margin. For the example here, the total value of the
futures contracts when the hedge is placed in September is $97,500 ($6.50 per bushel * 5000 per
contract * 3 contracts). Margins vary by broker and market conditions, and hedgers usually have
lower initial margin requirements than futures speculators. For the example above, assume the
producer must post $1000 initial margin for each futures contract sold. The total initial margin
would be $3000.
Even though the hedger is a seller, a margin account must be maintained. The sales price being
established through the hedged position will not be realized until the soybeans are sold in the
cash market and the futures position eliminated. In the meantime, however, prices will change
and this has implications for the hedger’s futures trading account.
Futures contracts are marked to market daily. This means that all futures profits and losses must
be settled each day. This is what causes margin calls, or the requirement for futures traders to
add to their futures margin account when prices move against their position. For a hedger who
has sold futures contracts, margin calls result when the futures prices move above the price at
which the hedger sold. If a hedger were to exit the futures market at a price above the initial
selling price, he/she would buy the futures contract back at a price higher than it was sold for,
and generate a financial loss. To insure against a default on a potential futures loss, hedgers who
sold futures before a price rise would need to deposit additional money in their futures margin
account in order to keep their hedged position. The margin call simply brings the value of their
performance bond back to the initial margin level.
Usually a small loss is allowed before a margin call occurs. The point at which a margin call is
initiated is called the maintenance margin. Once the value of the hedgers futures account reaches
the maintenance margin, an additional deposit must be made to the futures account to bring its
value back to the initial margin or the futures position cannot be maintained. For this example,
assume the maintenance margin is $750 per contract. The hedger’s futures position could then
deteriorate by a total of $250 (or 5 cents per bushel) before an additional deposit to the futures
account would be required.
For a hedger, a margin call during the hedge period should not be considered a loss since it is
associated with a more valuable cash commodity, and the net expected selling price at the end of
the hedge period has not changed. However, it can still create cash flow problems if the hedger
is not sufficiently capitalized to make the margin calls before the cash commodity is ready for
sale. One solution to this problem is to work with an agricultural lender who can provide a line
of credit to facilitate the hedge activity. While all lenders do not provide this service, many
realize that it is in their best interest to have the price of a commodity whose proceeds will be
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Hedging
used to service a production or business loan protected against adverse price movements, and
they are willing to help customers with hedging programs.
Under most circumstances, a hedger who sold futures contracts initially would buy those
contracts back before the contracts expire in order to offset the hedged position. Grain contracts
require physical delivery at contract expiration, thus any hedger who did not buy back a futures
hedge would be required to deliver soybeans against a futures contract sale. However, the
soybeans would have to have already been graded and certified for delivery against a futures
contract commitment, meaning a producer could not simply deliver the cash soybeans her or she
was growing into the futures market. Majority of the contracts in the market will be closed out
prior to the actual delivery dates by taking offsetting positions. Only few contracts will be
delivered in accordance with the delivery process.
Long Hedge or Hedging a Purchase Price
The mechanics of hedging a commodity to be purchased in the cash market at a later date are
similar to the sales hedge described above. The one difference is that a purchase hedge is
initiated by buying a futures contract. This is also called as a long hedge. When the initial trade
is the purchase of a futures contract, the seller is said to be “long”, in the market. The seller has
sold a commitment to take delivery of a commodity.
As prices rise, the cash commodity to be purchased later is becoming more expensive, but
futures prices are also rising, generating a profit in the futures position. This profit is used to
offset the increased price of the cash commodity, and, if basis has been forecast accurately, the
net purchase price originally established by the hedge becomes the effective price paid for the
cash commodity.
Assume it is November 1 and a dairy producer would like to lock in a purchase price for 15,000
bushels of corn to be bought in June and used as feed next summer. By hedging in a specific
corn futures contract month, a dairy farmer effectively locks in the price he/she will pay for corn
for the summer feeding period. In the example here, the farmer can hedge 15,000 bushels of
corn to be bought in the cash market in June by buying 3 July corn futures contracts (i.e.,
contracts for the delivery of corn next July). The important information for the farmer is the
current futures price for July delivery, and the expected basis in June (i.e., the difference between
the June cash corn price July futures price in June).
The purchase price hedge is illustrated in example 2. It considers the four scenarios covered in
the selling hedge. Again, as long as the producer has accurately forecast the June basis, the
hedged purchase price will be realized whether corn prices move up or down over the hedge
period. The only thing that will affect the actual purchase price relative to the expected price
established by the hedge is a basis that differs from the expected basis.
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Example 2. Long Hedge or Hedging a Purchase Price.
Assume it is November 1 and a dairy farmer wants to lock in the purchase price for 15,000
bushels of corn to be bought in June. The farmer would need to purchase 3 July corn contracts to
hedge June corn purchases. The expected basis in June is $0.15 under July contract. The
expected June purchase price is derived by adjusting the July futures price traded on November 1
for the expected basis in June and the futures broker’s commission.
Date
Futures Market
Cash Market
Basis
Nov 1
Dairy farmer buys July corn
contracts
Establishes an expected June
purchase price of
$2.10 -$0.15 + $.01
(Futures + Basis + Comm.)
$2.36
Expected to be
$2.50
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Hedging
Scenario 1. Perfect Hedge (Raising prices): Assume the July futures corn futures price is $3.50
per bushel when cash corn is purchased in June, and the basis turns out as expected. The
producer buys cash soybeans for $3.35 per bushel (futures is $3.50 and the basis is -$0.15). He
then sells the July futures contract he bought on November 1 for $2.50 per bushel. The basis was
accurately forecast and his net purchase price was as expected.
Date
Futures Market
Cash Market
June
Dairy farmer sells 3 July corn
futures contracts for $3.50per
bushel.
Buys 15,000 bushels of corn
from a local coop
Bought on Nov 1 $2.50
Sold on June 1
$3.50
$10.50
Futures profit
Broker’s comm.
$1.00
- $0.01
-----Net Futures profit $0.99
Cash price
$3.35
Futures profit -$ 0.99
-------
Basis
-$0.15
(No change in
basis)
Net Purchase Price $2.36
Note that the futures profit is subtracted from, and the broker’s commission added to the net
buying price of the dairy farmer. These items affect the farmer’s net corn purchase price. The
combination of a cash price of $3.35/bu. minus a futures profit of $0.99 nets the dairy producer
an effective corn price of $2.36 /but, which is what was expected.
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Scenario 2. Perfect Hedge (Declining prices): Assume the July futures corn futures price is
$1.50 per bushel when cash corn is purchased in June, and the basis turns out as expected. The
producer buys cash soybeans for $1.35 per bushel (futures is $1.50 and the basis is -$0.15). He
then sells the July futures contract he bought on November 1 for $2.50 per bushel. The basis was
accurately forecast and his net purchase price was as expected.
Date
Futures Market
Cash Market
November
1997
(futures)
Dairy farmer sells 3 July corn
futures contracts for $1.50 per
bushel.
Buys 15,000 bushels of corn
from a local coop
January
1998 (cash)
Bought on Nov 1 $2.50
Sold on June 1
$1.50
Futures loss
$1.00
Broker’s comm. + $0.01
-----Net Futures loss $1.01
Cash price
Futures loss
Basis
$1.35
+$1.01
-------
-$0.15
(No change in
basis)
Net Purchase Price $2.36
The combination of a cash price of $1.50/bu. plus a futures loss of $1.01 nets the dairy farmer an
effective corn purchase price of $2.36 /bushel, which is what was expected.
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Scenario 3. Imperfect Hedge (Basis risk: Weakening basis): This is the same as scenario 1,
except in this case the basis turns out to be weaker than expected by $0.10/bu. A weaker basis
means that the cash price is lower relative to futures than had been expected. If the basis is
weaker by 10 cents, the cash price is 10 cents lower than would have been the case if the basis
forecast had been correct.
Date
Futures Market
Cash Market
November
1997
(futures)
Dairy farmer sells 3 July corn
futures contracts for $3.50per
bushel.
Buys 15,000 bushels of corn
from a local coop
Bought on Nov 1 $2.50
January
$3.50
1998 (cash) Sold on June 1
Cash price
$3.25
Futures profit -$ 0.99
-------
Basis
-$0.25
(10 cents weaker
than expected)
Futures profit
Broker’s comm.
$1.00
- $0.01
-----Net Purchase Price $2.26
Net Futures profit $0.99
While the futures hedge offset the increase in cash prices, the unexpected weakening of the basis
did result in a lower net purchase price than originally anticipated. For a long hedger weakening
basis gives a better net buying or purchase price.
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Scenario 4. Imperfect Hedge (Basis risk: Strengthening basis): This is similar to scenario 3,
except that the basis ends up stronger than expected by $0.10 /bushel. A stronger than expected
basis means that the cash price is higher relative to futures than had been originally anticipated.
Date
Futures Market
Cash Market
November
1997
(futures)
Dairy farmer sells 3 July corn
futures contracts for $3.50per
bushel.
Buys 15,000 bushels of corn
from a local coop
Bought on Nov 1 $2.50
January
$3.50
1998 (cash) Sold on June 1
$1.00
- $0.01
-----Net Futures profit $0.99
Cash price
$3.45
Futures profit -$ 0.99
-------
Futures profit
Broker’s comm.
Basis
-$0.050
(10 cents
stronger than
expected)
Net Purchase Price $2.46
This time the dairy farmer ends up worse off then expected as the result of a stronger basis.
Futures prices over the hedge period rose by less than cash prices resulting in a stronger than
expected cash market. This leads to a higher net purchase price than originally anticipated. For a
long hedger strengthening basis gives a worse net buying price.
Conclusion
The net purchase price of a hedged cash commodity will not change regardless of
whether prices rise or fall over the hedge period as long as the basis is accurately forecast.
Once a commodity is hedged, price risk has been traded for basis risk. It is critical to have as
accurate an expectation of basis as possible in order to minimize the possibility of incurring a
net purchase price that is greater than the expected purchase price.
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Calculating the expected return from a buyer’s hedge is slightly different than the calculations
for a selling hedge. Any costs incurred in facilitating the hedge activity results in increasing the
effective price paid by the buyer for the final commodity. To compute the estimated purchase
price of a commodity protected through a hedge, the hedger takes the futures price, adjusts it for
the basis, and then adds the futures broker’s commission. A template for calculating the
expected net buying price from a hedged position is presented in table 2.
Table 1. Template for Calculating Expected Net Purchase Price from a Long Hedge.
Futures Price
_________________
+ Expected Basis
_________________
+ Brokers Commission
__________________
__________________________________________
= Expected Net Selling Price
__________________________________________
Just like the selling hedge, a purchase hedge requires an initial deposit in a futures trading
account, and the account must be maintained as the futures positions are marked to market. The
difference is that margin calls for a buyer occur as prices drop, because the value of the buyer’s
futures position is decreasing. However, this should not be viewed as a financial loss because
falling prices mean the cash commodity that will eventually be bought is also decreasing in
value, and the net purchase price that was established with the hedge is being maintained.
Unlike the seller’s hedge, a stronger then expected basis results in a less favorable outcome than
anticipated by the corn buyer, while a weaker basis improves the buyer’s market position. A
stronger than expected basis means that the cash price paid by the dairy farmer is higher relative
to futures than had been expected. A weaker basis means the buyer’s price is less relative to the
corn futures price than had been initially expected.
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Ten Don’ts in Hedging
1) Don’t enter the futures market until you understand how to use it.
2) Don’t ask your broker to make management decisions for you.
3) Don’t combine hedging and speculating.
4) Don’t hedge unless you “know” your “basis”.
5) Don’t hedge if you can’t meet additional margin calls.
6) Don’t view futures markets as an outlet for delivery of your crop.
7) Don’t think of futures markets as a way to get higher prices.
8) Don’t lift your hedge before you buy or sell your commodity in the cash market.
9) Don’t forget that hedging insulates you from subsequent major price changes – both
downward and upward.
10) Don’t expect hedging to be panacea for poor management.
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Basis Records:
It is vital to keep proper basis records for a successful hedging program. You should develop
worksheets to record the basis information for the markets that you use to market the commodity
and also the appropriate futures months. Following is an example of worksheet that records the
corn cash prices, July futures price and basis for the mid day of the week (Wednesday).
An Example of Corn Basis Records
Date
(Wednesday of the week)
Cash Price
July Futures
Closing Price
Basis
1-5
$3.17
$3.27
-10
1-12
$3.22
$3.37
-15
1-19
$3.14
$3.29
-15
1-26
$3.20
$3.31
-11
2-2
$3.21
$3.35
-14
2-9
$3.16
$3.32
-16
2-16
$3.11
$3.34
-13
2-23
$3.16
$3.26
-10
3-1
3-8
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Hedging
Exercises
Exercise 1: Futures Contracts
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Develop an understanding of the mechanics of futures contracts
Learn how the futures and cash markets interact
Discover how selling below and above the futures contract price affects the net price
During March, 2002 you sell a December futures contract for soybeans at $5.10. You close out
the contract in December and sell cash beans at the Grainville Elevator in the same month. The
CBOT price at the time is $4.80. The local December basis is $0.30. Calculate your net price on
the soybeans.
Calculate the net price received for the beans if the CBOT price is $5.40 at the time you close the
contract and sell the beans.
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Hedging
Exercise 2: Futures Contracts
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Learn how futures contracts and local basis interact to create marketing opportunities
Learn how to calculate net selling price
Assume that in August when his crop looks quite favorable, a farmer observes that the futures
market is offering $3.25 per bushel for December delivery of corn. He knows from the historical
basis records that he kept the basis is 10 cents under the December futures contract. He lifts the
hedge November when the December futures are trading at $3.10.
Question:
By hedging in the December futures at what price he can lock in if there is no basis
risk?
What is the final net selling price if the basis at the time of actual sale is minus 20
cents?
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Hedging
Exercise 3: Futures Contracts
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Discover the risks that are incurred when cash sales are disconnected from the
corresponding futures positions
You have 3,000 bushels of soybeans to market. You sell a futures contract for March beans (see
CBOT price data sheet). You close the contract and sell cash beans in late February at Grainville
Elevator. The CBOT price at the time is $5.41. Using the Grainville basis calculated in Exercise
1, what price did you net on the beans?
The market looks very strong in February when you close out your futures position ($5.41). You
decide to hold onto the beans. You end up selling them to Grainville Elevator in June when the
CBOT price is $5.02. What price did you net on your beans?
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