ECON 337:
Agricultural Marketing
Chad Hart
Assistant Professor
chart@iastate.edu
515-294-9911
Econ 337, Spring 2012
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
Soybeans
Trader Type
Hedger/Speculator
Hedger/Speculator
Initial
$2,363
$3,375
Maintenance
$1,750
$2,500
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 337, Spring 2012
Margin Calls
Margin accounts are rebalanced each day
Depending on the value of futures
Settlement price
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) and the
balance is brought back up to the Initial amount
Econ 337, Spring 2012
Margin Example
Let’s say I went short on May 2012 corn
$6.5825/bushel on Jan. 11
Along with selling a corn futures contract, I have to
establish a margin account and deposit $2,363 in it
On Jan. 12, the May 2012 corn futures price moved
to $6.1825/bushel
Since I’ll be selling the futures contract later, this
price move is in my favor
Econ 337, Spring 2012
Margin Example
I gained 40 cents per bushel and since the contract
is for 5,000 bushels, that’s a gain of $2,000
At the end of the day (Jan. 12), $2000 is deposited
into my margin account, raising the account balance to
$4,363
Since $4,363 is greater than the “Maintenance” level,
I will not receive a margin call
Econ 337, Spring 2012
Margin Example #2
Let’s say, instead of going short, I went long on May
2012 corn
$6.5825/bushel on Jan. 11
Along with buying a corn futures contract, I have to
establish a margin account and deposit $2,363 in it
On Jan. 12, the May 2012 corn futures price moved
to $6.1825/bushel
Since I’ll be selling back the futures contract later,
this price move is not in my favor
Econ 337, Spring 2012
Margin Example #2
I lost 40 cents per bushel and since the contract is
for 5,000 bushels, that’s a loss of $2,000
At the end of the day (Jan. 12), $2,000 is to be taken
from my margin account, lowering the account balance
to $363
Since $363 is less than the “Maintenance” level, I will
receive a margin call and be asked to deposit $2,000
more into the account or to close out the futures
position
The $2,000 brings the account balance back up to
the initial requirement
Econ 337, Spring 2012
Margin Example – Going Short
Date
Price
Gain
Margin
Call
Account
Balance
$2,363
1/6/12
$6.5075
1/9/12
$6.595
-$437.50
$1,925.50
1/10/12
$6.5925
+$12.50
$1,938
1/11/12
$6.5825
+$50
$1,988
1/12/12
$6.1825
+$2,000
$3,988
1/13/12
$6.065
+$587.50
$4,575.50
Econ 337, Spring 2012
Margin Example – Going Long
Date
Price
Gain
Margin
Call
Account
Balance
$2,363
1/6/12
$6.5075
1/9/12
$6.595
+$437.50
$2,800.50
1/10/12
$6.5925
-$12.50
$2,788
1/11/12
$6.5825
-$50
$2,738
1/12/12
$6.1825
-$2,000
1/13/12
$6.065
-$587.50
Econ 337, Spring 2012
$1,625
$2,363
$1,775.50
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 337, Spring 2012
Hedgers
Farmers, livestock producers
Merchandisers, elevators
Food processors, feed manufacturers
Exporters
Importers
What happens if futures market is restricted
to only hedgers?
Econ 337, Spring 2012
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 337, Spring 2012
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 337, Spring 2012
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 337, Spring 2012
Econ 337, Spring 2012
Cash
Futures
12/3/2011
11/3/2011
10/3/2011
9/3/2011
8/3/2011
7/3/2011
6/3/2011
5/3/2011
4/3/2011
3/3/2011
2/3/2011
1/3/2011
$ per bushel
8.00
Cash vs. Futures Prices
Iowa Corn in 2011
7.50
7.00
6.50
6.00
5.50
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 337, Spring 2012
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 337, Spring 2012
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 337, Spring 2012
Short Hedge Expected Price
 Expected price =
Futures prices when I place the hedge
+ Expected basis at delivery
– Broker commission
Econ 337, Spring 2012
Short Hedge Example
 As of Jan. 13,
Nov. 2012 soybean futures
Historical basis for Nov.
Rough commission on trade
Expected price
($ per bushel)
11.70
-0.30
-0.01
11.39
 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 337, Spring 2012
Prices Went Up, Hist. Basis
 In November, buy back futures at $14.00 per
bushel
Nov. 2012 soybean futures
Actual basis for Nov.
Local cash price
Net value from futures
($ per bushel)
14.00
-0.30
13.70
-2.31
($11.70 - $14.00 - $0.01)
Net price
Econ 337, Spring 2012
11.39
Prices Went Down, Hist. Basis
 In November, buy back futures at $10.00 per
bushel
Nov. 2012 soybean futures
Actual basis for Nov.
Local cash price
Net value from futures
($ per bushel)
10.00
-0.30
9.70
+1.69
($11.70 - $10.00 - $0.01)
Net price
Econ 337, Spring 2012
11.39
16
14
12
10
8
6
4
2
0
-2
-4
Futures Price ($ per bushel)
Cash Price
Econ 337, Spring 2012
Futures Return
Net
.0
0
14
.5
0
13
.0
0
13
.5
0
12
.0
0
12
.5
0
11
.0
0
11
.5
0
10
10
.0
0
Hedging Nov. 2012 Soybeans @ $11.70
9.
50
9.
00
Net Price ($ per bushel)
Short Hedge Graph
Prices Went Down, Basis Change
 In November, buy back futures at $10.00 per
bushel
Nov. 2012 soybean futures
Actual basis for Nov.
Local cash price
Net value from futures
($ per bushel)
10.00
-0.10
9.90
+1.69
($11.70 - $10.00 - $0.01)
Net price
 Basis narrowed, net price improved
Econ 337, Spring 2012
11.59
Long Hedgers
Processors or feeders that plan to buy a
commodity in the future
Are hurt by a price increase
Buy the futures initially
Sell the futures contract (offset) when they
buy the physical commodity
Econ 337, Spring 2012
Long Hedge Example
 An ethanol plant will buy 50,000 bushels of
corn in December
 The long hedge is to protect the ethanol plant
from rising corn prices between now and
December
 Since the plant is using the corn, they are
considered short in corn
Econ 337, Spring 2012
Long Hedge Example
 To create an equal and opposite position, the
plant manager would buy 10 December corn
futures contracts
Each contract is for 5,000 bushels
The plant manager would long the futures,
opposite their short from usage
 As prices increase (decline), the futures
position gains (loses) value
Econ 337, Spring 2012
Long Hedge Expected Price
 Expected price =
Futures prices when I place the hedge
+ Expected basis at delivery
+ Broker commission
Econ 337, Spring 2012
Long Hedge Example
 As of Jan. 13,
Dec. 2012 corn futures
Historical basis for Dec.
Rough commission on trade
Expected local net price
($ per bushel)
5.55
-0.25
+0.01
5.31
 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 337, Spring 2012
Prices Went Up, Hist. Basis
 In December, sell back futures at $6.00 per
bushel
Dec. 2012 corn futures
Actual basis for Nov.
Local cash price
Less net value from futures
-($6.00 - $5.55 - $0.01)
Net cost of corn
($ per bushel)
6.00
-0.25
5.75
-0.44
5.31
 Futures gained in value, reducing net cost of
corn to the plant
Econ 337, Spring 2012
Prices Went Down, Hist. Basis
 In December, sell back futures at $4.00 per
bushel
Dec. 2012 corn futures
Actual basis for Nov.
Local cash price
Less net value from futures
-($4.00 - $5.55 - $0.01)
Net cost of corn
($ per bushel)
4.00
-0.25
3.75
+1.56
5.31
 Futures lost value, increasing net cost of corn
Econ 337, Spring 2012
Long Hedge Graph
8
Net Price ($ per bushel)
Hedging Dec. 2012 Corn @ $5.55
6
4
2
0
-2
Futures Price ($ per bushel)
Cash Price
Econ 337, Spring 2012
Futures Return
Net
8.
00
7.
50
7.
00
6.
50
6.
00
5.
50
5.
00
4.
50
4.
00
3.
50
3.
00
-4
Prices Went Down, Basis Change
 In December, sell back futures at $4.00 per
bushel
Dec. 2012 corn futures
Actual basis for Dec.
Local cash price
Less net value from futures
-($4.00 - $5.55 - $0.01)
Net cost of corn
($ per bushel)
4.00
-0.10
3.90
+1.56
5.46
 Basis narrowed, net cost of corn increased
Econ 337, Spring 2012
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 337, Spring 2012
Class web site:
http://www.econ.iastate.edu/~chart/Classes/econ337/
Spring2012/
Econ 337, Spring 2012