ECON 337: Agricultural Marketing Chad Hart Associate Professor Lee Schulz Assistant Professor

Futures Markets  Organized and centralized market  Today’s price for products to be delivered in the future  A mechanism of trading promises of future commodity deliveries among traders

Futures and Options  Market tools to help manage (share) price risks  Mechanisms to establish commodity trades among participants at a future time  Available from commodity exchanges / futures markets

Agricultural Futures Markets  Has some unique features due to the nature of agricultural businesses  Supply comes online a few times during the year  So at harvest, supply spikes, then diminishes until the next harvest  Production decisions are based price forecasts  Planting decisions can be made a full year (or more) before the crop price is realized  Users provide year-round demand  Livestock feeding, biofuel production, food demand

Futures Market Exchanges  Competitive markets  Open out-cry and electronic trading  Centralized pricing  Buyers and sellers are both in the market  Relevant information is conveyed through the bids and offers for the trades  Bid = the price at which a trader would buy the commodity  Offer = the price at which a trader would sell the commodity

CME Group   Products  Agricultural commodities  Corn, soy, cattle, hogs, etc.  Energy  Currency  Metals  Weather  Others

Futures Contracts  A legally binding contract to make or take delivery of the commodity  Trading the promise to do something in the future  You can “offset” your promise  Standardized contract  Form (weight, grade, specifications)  Time (delivery date)  Place (delivery location)

Soybean Futures  Form  5,000 bushels  No. 2 Yellow Soybeans (at price), No. 1 Yellow soybeans (at 6 cents over price), and No. 3 Yellow Soybeans (at 6 cents under price)  Time  Contract months: Sept, Nov, Jan, Mar, May, July, and August Source: CME Group

Soybean Futures Partial listing of delivery points Source: CME Group Rulebook

Delivery Points Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report CornSoybeans Wheat

Futures Contracts  No physical exchange takes place when the contract is traded (no actual commodity moves)  Payment is based on the price established when the contract was initially traded (prices can and will change before delivery is taken)  Deliveries can be made when the contract expires or the offsetting futures position must be taken to settle up  Deliveries occur on less than 5 percent of the traded contracts

Market Positions  You can either buy or sell initially to open a position in the futures market  “Make” a promise to make or take delivery  Do the opposite to close the position at a later date  “Offset” the promise (and no commodity changes hands)  Trader may also hold the position until expiration and make or take physical delivery of the commodity

Trading Futures Contracts  All trades through a licensed broker  Brokerage house has a “seat” at the exchange and is allowed to trade  Represented “on the floor” to exercise trade  Local broker to initiate transaction and manage account with client  Full service and discount brokers

CME Group   Open, High, Low, Last Price  Settlement Price  Volume  Open Interest  Daily Limits

Terms and Definitions  Basis  The difference between the spot or cash price and the futures price of the same or a related commodity.  Bear  Someone that thinks the price will decline  Bull  Someone that thinks the price will increase

Cash vs. Futures Prices Iowa Corn in 2013 The gap between the lines is the basis.

2013 Basis for Iowa Corn

Terms and Definitions  Clearing House  The division of the futures exchange through which all trades made must be confirmed, matched and settled each day until offset or delivered.  Commission  For futures contracts, the one-time fee charged by a broker to cover the trades you make to open and close each position.

Terms and Definitions  Long position  A position in which the trader has bought a futures contract that does not offset a previously established short position.  Short position  A position in which the trader has sold a futures contract that does not offset a previously established long position.

Going Short Sold Dec $4.55 What type of trader (bull or bear) would go short? What events would send prices in a favorable direction?

Going Long Bought Nov $11.20 What type of trader (bull or bear) would go long? What events would send prices in a favorable direction?

Class web site: Spring2014/ Have a great weekend!