Futures Markets CME Commodity Marketing Manual Chapter 2

A Standardized Agreement Commodity (live cattle, feeder cattle, lean hogs, corn, soybeans, wheat, milk, and so on) Quantity (number of bushels of grain or pounds of livestock as well as the range of weight for individual animals) Quality (specific U.S. grades) Delivery point (location at which to deliver commodity) or cash settlement* Delivery date (within month that contract terminates)

Corn Specs Contract Size5,000 bushels Deliverable Grades No. 2 Yellow at par, No. 1 yellow at 1 1/2 cents per bushel over contract price, No. 3 yellow at 1 1/2 cents per bushel under contract price Tick Size 1/4 cent/bushel ($12.50/contract) Price Quote Cents/bushel Contract Months Dec, Mar, May, Jul, Sep Last Trading Day The business day prior to the 15th calendar day of the contract month. Last Delivery Day Second business day following the last trading day of the delivery month. Trading HoursOpen Auction: 9:30 a.m. - 1:15 p.m. Central Time, Mon- Fri. Electronic: 6:30 p.m. - 6:00 a.m. and 9:30 a.m. - 1:15 p.m. Central Time, Sun.-Fri. Daily Price Limit Twenty cent ($0.20) per bushel ($1,000/contract) above or below the previous day's settlement price. No limit in the spot month (limits are lifted beginning on First Position Day).

Soybean Specs Contract Size5,000 bushels Deliverable Grades No. 2 Yellow at par, No. 1 yellow at 6 cents per bushel over contract price and No. 3 yellow at 6 cents per bushel under contract price**No. 3 Yellow Soybeans are only deliverable when all factors equal U.S. No. 2 or better except foreign material. Tick Size 1/4 cent/bu ($12.50/contract) Price Quote Cents bushel Contract Months Sep, Nov, Jan, Mar, May, Jul, Aug Last Trading Day The business day prior to the 15th calendar day of the contract month. Last Delivery Day Second business day following the last trading day of the delivery month. Trading HoursOpen Auction: 9:30 a.m. - 1:15 p.m. Central Time, Mon- Fri. Electronic: 6:31 p.m. - 6:00 a.m. and 9:30 a.m. - 1:15 p.m. Central Time, Sun.-Fri. Daily Price Limit 50 cents/bu ($2,500/contract) above or below the previous day's settlement price. No limit in the spot month

Hogs Specs Trade Unit: 40,000 pounds Settle Method: Cash Settled Point Descriptions:1 point = $.01 per hundred pounds = $4.00 Contract Listing: Feb Apr, May, Jun, Jul, Aug, Oct, and Dec Hours: 9:05 a.m. to 1:00 p.m. Limits: $0.03/lb, $1200

Live Cattle Specs Trade Unit: 40,000 pounds Settle Method: Physically Delivered Point Descriptions:1 point = $.01 per hundred pounds = $4.00 Contract Listing: Seven months in the Even Monthly Cycle: Feb, Apr, Jun, Aug, Oct, Dec. Hours: 9:05 a.m. to 1:00 p.m. Limits: $0.03/lb, $1200

Feeder Cattle Specs Trade Unit: 50,000 pounds Settle Method: Cash Settlement Point Descriptions:1 point = $.01 per hundred pounds = $5.00 Contract Listing: Jan, Mar, Apr, May, Aug, Sep, Oct and Nov. Eight months at time. Hours: 9:05 a.m. to 1:00 p.m. Limits: $0.03/lb, $1500

Class III Milk Specs Trade Unit: 200,000 lbs. Settle Method: Cash Settlement Point Descriptions: 1 point = $.01 per hundred weight = $20 per contract Listing: 24 months. Hours: 9:40 a.m.-1:10 p.m. Limits: There shall be no trading at a price more than $0.75 per hundredweight above or below the previous day's settlement price.

Offsetting Futures You remove your delivery obligation by offsetting (selling or buying) the contract that you bought (sold)

Hedging Risk Management Tool Used by both producers and buyers Attempt to maintain a level price by offsetting a loss in one market by a gain in another

Short Hedge Producers with a commodity to sell at some point in the future Short hedgers 1 Sell the futures contract first 2 Buy the futures contract (offset) when they sell the physical commodity

Long Hedge Processors or feeders that plan to buy a commodity in the future Long hedgers 1 Buy the futures first 2 Sell the futures contract (offset) when they buy the physical commodity

Video: Taking Control of Your Future

Worksheet Grain Price Hedging Basics (File A2-60)

Short Hedge Example Day 1: Think that the new crop (Dec) corn price is going to decline Step 1: Decide to Sell a December corn futures contract by calculating expected price from hedging Futures bid$2.34 Adjust for basis-.31 Subtract commission-.01 Expected hedge price$2.02

Short Hedge Example Step 2: Call your broker and place order to sell Dec corn at the market Step 3: Broker forwards order to CBOT where the broker's representative runs the order to the pit and tries to fill the order.

Short Hedge Example Step 4: The order is filled at $2.34 Step 5: Broker calls to confirm fill Step 6: Send margin money to broker Initial margin account level is $750 Must maintain at least $600 in margin account at end of each day

Short Hedge Example Day 2: Closing price is $2.38 We sold at $2.34 Market is$2.38 We are behind by -$0.04 On 5,000 bushels = $200 Send broker $200 on Day 2

Short Hedge Example At some later date we decide to offset our position Last Day: Call broker and place order to buy Dec corn at the market Two things could have happened Prices are higher than initially Prices are lower than initially

Short Hedge Example Case 1: Prices are higher => $2.56 Calculate returns per bushels Sold on Day $2.34 Bought back Gross future return -$0.22 $50/contract -$0.01 Net return per bushel -$0.23 Local cash price$2.25 Net price$ =$2.02

Short Hedge Example Convert to contract returns Gross returns-$0.23 Contract = 5,000 bushels -$1,150 Because we settled the margin account every day the broker has this amount plus at least $600 minimum margin. The remaining margin balance is returned.

Short Hedge Example Case 2: Prices are lower => $2.20 Calculate returns per bushels Sold Day $2.34 Bought back $2.20 Gross return +$0.14 $50/contract -$0.01 Net return per bushel +$0.13 Local cash price$1.89 Net price$ = $2.02

Short Hedge Example Convert to contract returns Gross returns+$0.13 Contract = 5,000 bushels+$650 Because the margin account is settled every day the broker has this amount plus the $750 initial margin. We are returned the $1,400.

Worksheet Using Hedging in a Marketing Program (File A2-61)

Long Hedge Example Day 1: Think that the new crop (Dec) corn price is going to rise Step 1: Decide to Buy a December corn futures contract by calculating expected price from hedging Futures bid$2.34 Adjust for basis-.31 Subtract commission-.01 Expected hedge price$2.02

Long Hedge Example Step 2: Call your broker and place order to buy Dec corn at the market Step 3: Broker forwards order to CBOT where the broker's representative runs the order to the pit and tries to fill the order.

Long Hedge Example Step 4: The order is filled at $2.34 Step 5: Broker calls to confirm fill Step 6: Send margin money to broker Initial margin account level is $750 Must maintain at least $600 in margin account at end of each day

Long Hedge Example Day 2: Closing price is $2.38 You bought at $2.34 Market is$2.38 Your are ahead by $0.04 On 5,000 bushels = $200 $200 is deposited in your margin account on Day 2

Long Hedge Example At some later date we decide to offset our position Last Day: Call broker and place order to sell Dec corn at the market Two things could have happened Prices are higher than initially Prices are lower than initially

Long Hedge Example Case 1: Prices are higher => $2.56 Calculate returns per bushels Bought on Day $2.34 Sold back Gross future return $0.22 $50/contract -$0.01 Net return per bushel $0.21 Local cash price$2.25 Net price$ =$2.04

Long Hedge Example Convert to contract returns Gross returns$0.21 Contract = 5,000 bushels $1,050 Because we settled the margin account every day the broker has this amount plus at least $600 minimum margin. The remaining margin balance is returned.

Long Hedge Example Case 2: Prices are lower => $2.20 Calculate returns per bushels Bought Day $2.34 Sold back $2.20 Gross return -$0.14 $50/contract -$0.01 Net return per bushel -$0.15 Local cash price$1.89 Net price$ = $2.04

Homework Using Hedging in a Marketing Program (File A2-61b)

Worksheet Hedging of Livestock (File B2-50)

Chapter Two Exercise 1.For an expected harvest of 40,000 bushels of wheat, how many CBOT wheat futures contracts would you sell to hedge the sale? 2.You plan to buy 195 head of feeder cattle or about 150,000 pounds. How many CME Feeder Cattle futures contracts would you buy to hedge the purchase? 3.You sell CME Lean Hog futures contracts at $56.00/cwt. You expect the basis to be $1.50 under. What is your target sales price? 4.You buy corn futures contracts at $2.55/bushel to hedge a corn purchase. You expect the basis to be $0.20 under. What is your target purchase price?

Chapter Two Exercise 5.If the futures price is at $6.25/bushel, what is the value of one soybean contract? 6.You bought CME Feeder Cattle futures at $72.00/cwt and sold them back at $ You bought the cattle in the cash market at $ What is the total price you paid for the cattle? 7.You bought corn futures at $2.60/bushel and sold them back at $2.50. You bought corn in the cash market at $2.25. What is the total price you paid for the corn? 8.You hedged the sale of hogs by selling four contracts and then offsetting four futures contracts. The hedged return was $3.00/cwt. Your broker charged you a total commission of $200. What is your futures account net gain?

Hedging Workshop

20 Rules of Successful Hedging

1. Know why you are hedging

2. Discuss your hedge with your banker

3. Let your lender finance your hedge

4. Find a hedge broker

5. Draft a farmer/broker/lender agreement

6. Know your production costs

7. Know your price trend

8. Use basis to your advantage

9. Don’t hedge to fast

10. Start small, go slow

11. Consider the Uncontrollables

12. Control your hedge account

13. Keep good trading records

14. “IF” you speculate open a separate account (p.s. Don’t Speculate)

15. Involve your partner

16. Categorize Yourself

17. Stick to your guns

18. Develop trading discipline

19. Don’t blame your broker

20. Make your own decisions

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