Agribusiness Library
Lesson 060097:
Introduction to Commodity Trading
1
Objectives
1. Identify and briefly describe the possible
methods of marketing commodities.
2. Describe cash sales, and examine the
advantages and disadvantages of cash sales.
3. Describe forward contracting, and examine
the advantages and disadvantages of forward
contracting.
4. Investigate the impact of basis on marketing,
and demonstrate the ability to calculate basis.
2
Terms







basis
basis contract
cash sale
deferred pricing agreement
forward contract
futures contract
option on a futures contract
3
What are the methods of
marketing commodities?
The methods of marketing commodities are
cash sales, forward contracts, futures contracts,
and options on futures contracts. These
methods can be used individually or in
combination.
4
What are the methods of
marketing commodities?
A. A cash sale is a sale that
occurs at the point of
delivery in which the seller
receives immediate
payment for a commodity
at the price in effect that
day.
5
What are the methods of
marketing commodities?
B. A forward contract is a
contract in which a buyer
and a seller agree to the
purchase and sale of a
definite quantity and quality
of commodity at a specific
price on a specific date of
delivery. This allows the
price to be set, or locked in, thus providing
protection from price changes.
6
What are the methods of
marketing commodities?
C. A futures contract is a contract commonly made
through a brokerage house that transacts the
trading for an individual. This contract allows the
individual to buy or sell a commodity at a future
date.
D. An option on a futures contract is the right, but
not the obligation, to buy or sell a futures contract
at a specific price before a specific time. Options
provide price protection and the opportunity to
benefit from favorable price changes.
7
What are cash sales? What are the
advantages and disadvantages?
The cash sale of a commodity occurs at the
point of delivery to the cash market, with
payment at the price in effect that day.
A. A producer can deliver hogs to a packer or
grain to an elevator and get cash right away.
This type of transaction is easy but is one of
the riskiest marketing choices.
8
What are cash sales? What are the
advantages and disadvantages?
B. A cash market is any physical location where a
product is bought or sold for cash.
C. Advantages of cash sales for producers are:
1. They are easy to transact.
2. They provide immediate payment.
3. There is no set quantity.
D. Disadvantages of cash sales for producers are:
1. They maximize risk.
2. There is no price protection.
9
What are cash sales? What are the
advantages and disadvantages?
E. A deferred pricing agreement is another
avenue for making a cash sale. The commodity
is delivered, but the price is set later. This allows
grain producers to deliver grain, reduce the
physical risk of holding the grain (corn, wheat),
and reduce the storage cost without having to
agree to the current price. A producer may
deliver wheat to a processor at the end of
harvest in October and then choose a price at a
later time—for example, between date of
delivery and February.
10
What is forward contracting?
What are the advantages and
disadvantages of forward contracting?
In a forward contract, the buyer and the seller
agree to the purchase and sale of a definite
quantity and quality of commodity at a specific
price on a specific date of delivery. This allows
the price to be set, or locked in, thus providing
protection from price changes.
11
What is forward contracting?
What are the advantages and
disadvantages of forward contracting?
A. Forward contracting allows a producer and a
buyer to negotiate price for a later delivery. This
marketing approach provides price protection if
an unfavorable price change occurs but provides
no benefits if a favorable price change occurs.
The negotiated price still applies whether the
price goes up or down.
B. Besides price, the written agreement should
include quantity, quality, delivery time, and
location.
12
What is forward contracting?
What are the advantages and
disadvantages of forward contracting?
C. Advantages of forward contracts
for producers are:
1. They are usually easy to understand.
2. They minimize risk.
3. They guarantee the sale of a given quality
and quantity of a commodity.
4. They provide price protection.
5. They allow the computation of profit once
production costs are determined.
13
What is forward contracting?
What are the advantages and
disadvantages of forward contracting?
D. Disadvantages of forward contracts for
producers are:
1. They require delivery of a given quality and
quantity of a commodity.
2. There is no benefit from better prices.
14
What is forward contracting?
What are the advantages and
disadvantages of forward contracting?
E. Because a contract is a legally binding
agreement, it should be developed by a
lawyer and carefully reviewed by both
parties before signing. A contract should
include:
1. The names and addresses of the buyer
and the seller
2. The date of delivery
3. The price of the product
15
What is forward contracting?
What are the advantages and
disadvantages of forward contracting?
E. A contract should include (cont’d)
4. The quantity of the product
5. The quality of the product and how it will be
determined
6. Exactly how and when payment will be made
7. Penalties if either party defaults
8. The signatures of both parties
16
What is the impact of basis
on marketing?
Basis is the relationship between the local cash
market price and the futures market price.
A. The cost of delivery of a commodity to a
specific place is reflected in the futures price.
The cost of delivery of a commodity to a
different place is mirrored in the cash price.
Each of these costs includes transportation,
storage charges, and marketing costs.
Therefore, the basis can vary from one market
or location to another.
17
What is the impact of basis
on marketing?
B. Basis can be seen as consistently positive or
consistently negative and can change during the
futures contract length. Knowledge of basis
patterns and attention to local basis patterns is
essential in understanding the impact of basis
on the market.
18
What is the impact of basis
on marketing?
C. The basis is calculated by subtracting the price
of the nearby futures contract from the local
cash market price.
•
•
If the cash price for soybeans is $7.50 and the
futures price is $7.70, the basis is
$7.50 – $7.70 = –$0.20, or 20 cents under.
If the cash price for corn is $4.25 and the futures
price is $4.22, the basis is
$4.25 – $4.22 = +$0.03, or 3 cents over.
19
What is the impact of basis
on marketing?
C. As a basis value approaches positive integers,
it is said to be strengthening. As a basis value
becomes less positive, it is said to be
weakening.
20
Review
• Name the four methods of marketing
commodities.
• Name the advantages and disadvantages of
a cash sale.
• What are the important points that should be
in a forward contract?
• Define basis. How is it calculated?
21