ECON 339X:
Agricultural Marketing
Chad Hart
Assistant Professor
chart@iastate.edu
515-294-9911
Econ 339X, Spring 2011
John Lawrence
Professor
jdlaw@iastate.edu
515-294-7801
Margin Accounts
A margin account is an account that traders maintain
in the market to ensure contract performance. There
are minimum limits on the size of the account.
Crop
Corn
Corn
Soybeans
Soybeans
Trader Type
Hedger
Speculator
Hedger
Speculator
Initial
$1,500
$2,025
$3,250
$4,388
Maintenance
$1,500
$1,500
$3,250
$3,250
To trade, you must create a margin account with at
least the “Initial” amount and maintain at least the
“Maintenance” amount in the account at the end of
each trading day.
Econ 339X, Spring 2011
Margin Calls
Margin accounts are rebalanced each day
Depending on the value of futures
If your futures are losing value, money is taken out
of the margin account to cover the loss
If the account value falls below the “Maintenance”
level, you receive a margin call (a call to put
additional money in your margin account)
If your futures position is gaining value, money is
put into your margin account
Econ 339X, Spring 2011
Margin Example
Earlier, I went long on Dec. 2011 corn
$5.48/bushel on 1/11/11
Let’s say I’m a farmer, so I am considered a hedger
Along with buying a corn futures contract, I have to
establish a margin account and deposit $1,500 in it
On 1/12/11, the Dec. 2011 corn futures price moved
to $5.60/bushel
Since I’ll be selling the futures contract later, this
price move is in my favor
Econ 339X, Spring 2011
Margin Example
I gained 12 cents per bushel and since the contract
is for 5,000 bushels, that’s a gain of $600
At the end of the day (1/12/11), $600 is deposited
into my margin account, raising the account balance to
$2,100
Since $2,100 is greater than the “Maintenance” level,
I will not receive a margin call
Econ 339X, Spring 2011
Margin Example #2
Earlier, I also went short on Nov. 2011 soybeans
$12.73/bushel on 1/11/11
Along with selling a soybean futures contract, I have
to establish a margin account and deposit $3,250 in it
On 1/12/11, the Nov. 2011 soybean futures price
moved to $13.08/bushel
Since I’ll be buying back the futures contract later,
this price move is not in my favor
Econ 339X, Spring 2011
Margin Example #2
I lost 35 cents per bushel and since the contract is
for 5,000 bushels, that’s a loss of $1,750
At the end of the day (1/12/11), $1,750 is be taken
from my margin account, lowering the account balance
to $1,500
Since $1,500 is less than the “Maintenance” level, I
will receive a margin call and be asked to deposit
$1,750 more into the account or to close out the
futures position
The $1,750 brings the account balance back up to
the initial requirement
Econ 339X, Spring 2011
Margin Example #2
Date
Price
Gain
Margin
Call
Account
Balance
$3,250
$1,750
$3,250
1/11/11
$12.73
1/12/11
$13.08
-$1,750
1/13/11
$13.00
+$400
$3,650
1/14/11
$13.05
-$250
$3,400
1/18/11
$13.10
-$250
Econ 339X, Spring 2011
$100
$3,250
Market Participants
Hedgers are willing to make or take physical
delivery because they are producers or users
of the commodity
Use futures to protect against a price movement
Cash and futures prices are highly correlated
Hold counterbalancing positions in the two
markets to manage the risk of price movement
Econ 339X, Spring 2011
Hedgers
Farmers, livestock producers
Merchandisers, elevators
Food processors, feed manufacturers
Exporters
Importers
What happens if futures market is restricted
to only hedgers?
Econ 339X, Spring 2011
Market Participants
Speculators have no use for the physical
commodity
They buy or sell in an attempt to profit from price
movements
Add liquidity to the market
May be part of the general public,
professional traders or investment managers
Short-term – “day traders”
Long-term – buy or sell and hold
Econ 339X, Spring 2011
Market Participants
Brokers exercise trade for traders and are
paid a flat fee called a commission
Futures are a “zero sum game”
Losers pay winners
Brokers always get paid commission
Econ 339X, Spring 2011
Hedging
Holding equal and opposite positions in
the cash and futures markets
The substitution of a futures contract for a
later cash-market transaction
Who can hedge?
Farmers, merchandisers, elevators,
processors, exporter/importers
Econ 339X, Spring 2011
Econ 339X, Spring 2011
Cash
Futures
12/4/2010
11/4/2010
10/4/2010
9/4/2010
8/4/2010
7/4/2010
6/4/2010
5/4/2010
4/4/2010
6.00
3/4/2010
6.50
2/4/2010
1/4/2010
$ per bushel
Cash vs. Futures Prices
Iowa Corn in 2010
5.50
5.00
4.50
4.00
3.50
3.00
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
Econ 339X, Spring 2011
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
Econ 339X, Spring 2011
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
Econ 339X, Spring 2011
Short Hedge Example
 As of Tuesday,
Nov. 2011 soybean futures
Historical basis for Nov.
Rough commission on trade
Expected local hedged price
($ per bushel)
12.73
-0.25
-0.01
12.47
 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
Econ 339X, Spring 2011
Prices Went Up, Hist. Basis
 In November, buy back futures at $14.00 per
bushel
Nov. 2011 soybean futures
Actual basis for Nov.
Local cash price
Net value from futures
($ per bushel)
14.00
-0.25
13.75
-1.28
($12.73 - $14.00 - $0.01)
Net price
Econ 339X, Spring 2011
12.47
Prices Went Down, Hist. Basis
 In November, buy back futures at $10.00 per
bushel
Nov. 2011 soybean futures
Actual basis for Nov.
Local cash price
Net value from futures
($ per bushel)
10.00
-0.25
9.75
+2.72
($12.73 - $10.00 - $0.01)
Net price
Econ 339X, Spring 2011
12.47
16
14
12
10
8
6
4
2
0
-2
-4
Futures Price ($ per bushel)
Cash Price
Econ 339X, Spring 2011
Futures Return
Net
0
15
.0
0
14
.5
0
14
.0
0
13
.5
0
13
.0
0
12
.5
0
12
.0
0
11
.5
0
.0
11
.5
10
.0
10
0
Hedging Nov. 2011 Soybeans @ $12.73
0
Net Price ($ per bushel)
Short Hedge Graph
Prices Went Down, Basis Change
 In November, buy back futures at $10.00 per
bushel
Nov. 2011 soybean futures
Actual basis for Nov.
Local cash price
Net value from futures
($ per bushel)
10.00
-0.10
9.90
+2.72
($12.73 - $10.00 - $0.01)
Net price
 Basis narrowed, net price improved
Econ 339X, Spring 2011
12.62
Long Hedgers
Processors or feeders that plan to buy a
commodity in the future
Are hurt by a price increase
Buy the futures initially
Sell the futures contract (offset) when they
buy the physical commodity
Econ 339X, Spring 2011
Long Hedge Example
 An ethanol plant will buy 50,000 bushels of
corn in December
 The long hedge is to protect the ethanol plant
from rising corn prices between now and
December
 Since the plant is using the corn, they are
considered short in corn
Econ 339X, Spring 2011
Long Hedge Example
 To create an equal and opposite position, the
plant manager would buy 10 December corn
futures contracts
Each contract is for 5,000 bushels
The plant manager would long the futures,
opposite their short from usage
 As prices increase (decline), the futures
position gains (loses) value
Econ 339X, Spring 2011
Long Hedge Example
 As of Tuesday,
Dec. 2011 corn futures
Historical basis for Dec.
Rough commission on trade
Expected local net price
($ per bushel)
5.48
-0.25
+0.01
5.24
 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
Econ 339X, Spring 2011
Prices Went Up, Hist. Basis
 In December, sell back futures at $6.00 per
bushel
Dec. 2011 corn futures
Actual basis for Nov.
Local cash price
Less net value from futures
-($6.00 - $5.48 - $0.01)
Net cost of corn
($ per bushel)
6.00
-0.25
5.75
-0.51
5.24
 Futures gained in value, reducing net cost of
corn to the plant
Econ 339X, Spring 2011
Prices Went Down, Hist. Basis
 In December, sell back futures at $4.00 per
bushel
Dec. 2011 corn futures
Actual basis for Nov.
Local cash price
Less net value from futures
-($4.00 - $5.48 - $0.01)
Net cost of corn
($ per bushel)
4.00
-0.25
3.75
+1.49
5.24
 Futures lost value, increasing net cost of corn
Econ 339X, Spring 2011
Long Hedge Graph
8
Net Price ($ per bushel)
Hedging Dec. 2011 Corn @ $5.48
6
4
2
0
-2
Futures Price ($ per bushel)
Cash Price
Econ 339X, Spring 2011
Futures Return
Net
00
8.
50
7.
00
7.
50
6.
00
6.
50
5.
00
5.
50
4.
00
4.
50
3.
3.
00
-4
Prices Went Down, Basis Change
 In December, sell back futures at $4.00 per
bushel
Dec. 2011 corn futures
Actual basis for Dec.
Local cash price
Less net value from futures
-($4.00 - $5.48 - $0.01)
Net cost of corn
($ per bushel)
4.00
-0.10
3.90
+1.49
5.39
 Basis narrowed, net cost of corn increased
Econ 339X, Spring 2011
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
Econ 339X, Spring 2011
Class web site:
http://www.econ.iastate.edu/~chart/Classes/econ339/
Spring2011/
Econ 339X, Spring 2011