1 Basis and Price Formation Basis Basis is the difference between a cash price at a specific location and the price of a particular futures contract. The cash price offered to a grain producer for any given marketing strategy is a function of local basis. 2 3 Determination of Basis Major Factors • • COST OF STORAGE: Determines basis over a given crop year. Also affects the price difference between a nearby and a distant futures contract in a given crop year. COST OF TRANSPORTATION: Determines basis geographically. 4 Determination of Basis Other Factors: • Local supply and demand conditions • Grain quality • Intensity of local competition 5 Basis Basis = Cash-Futures Price ( or Futures - Cash Price) Calculated From Nearby Futures (Cash Next Futures Contract to Mature) Has Predictable Patterns (More Predictable Than Cash Prices) Not Perfectly Predictable (Basis Risk) Determines the Success of Hedge Strengthening and Weakening Basis Strengthen (less negative or more positive) 20 10 0 -10 -20 Cash prices increase relative to futures prices Weaken (less positive or more negative) Cash prices decrease relative to futures prices 7 8 Typical Grain Basis Pattern Futures Price Weakening Basis Cash Price Summer Strengthening Basis Harvest Basis Largest Fall Harvest Spring Predictable Basis Patterns 9 Futures > Cash Prior to Contract Maturity Futures = Cash Price at Contract Maturity Basis Widens Into Harvest Basis Narrows During Storage Season Futures and Cash Prices Move Together Basis is Predictable From Year to Year 10 Hedging Principle The Basis Determines the Success of A Hedge 11 Basis and Storage Costs $ Futures Price Basis Storage Costs Fall Harvest Spring Cash Price P harvest 12 Corn Storage Hedge Date October Cash Market Futures Market Harvest Price = $3.00 Sell July Fut. = $3.50 Est. June Basis = $.10 Storage Cost = $.30 Forward Price = $3.50-.10= $3.40 Storage Profit= $3.40 -3.00 - .30= $.10 June Cash Sale @ $3.30 Return to Hedge: Buy Back Fut. @ $3.40 $3.30 + $.10 = $ 3.40 13 Corn Basis for North West Wisconsin -0.20 -0.25 -0.30 -0.35 -0.40 -0.45 -0.50 -0.55 -0.60 Sep Oct Nov Dec Jan 1997-98 Feb Mar 1998-99 Apr May 1999-00 Jun July Aug 14 Corn Basis for North West Wisconsin -0.20 -0.25 -0.30 -0.35 -0.40 -0.45 -0.50 Sep Oct Nov Dec Jan Feb Mar Average Apr May Jun July Aug 15 Soybean Basis for North West Wisconsin -0.10 -0.20 -0.30 -0.40 -0.50 -0.60 -0.70 -0.80 -0.90 Sep Oct Nov Dec Jan 1997-98 Feb Mar 1998-99 Apr May 1999-00 Jun July Aug 16 Soybean Basis for North West Wisconsin -0.30 -0.35 -0.40 -0.45 -0.50 -0.55 -0.60 -0.65 Sep Oct Nov Dec Jan Feb Mar Apr May Jun July Aug Recording Basis 17 To record historical basis levels, collect closing futures prices for the contract closest to maturity (but not expiring in the current month) each Wednesday, and the corresponding cash price (collected later Wednesday or Thursday morning). Subtract the futures price from the cash price. Average the Wednesday basis calculations for each month to arrive at the average monthly basis level. 18 Finding Local Basis Information •Compile it yourself over several years. •Contact you local county extension office. •Contact your local grain brokers, lenders, market advisory services.