1. ECON 337: Agricultural Marketing Chad Hart Associate Professor chart@iastate.edu 515-294-9911 Lee Schulz Assistant Professor lschulz@iastate.edu 515-294-3356

2. 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

3. 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

4. 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

5. Short Hedge Expected Price  Expected price = Futures prices when I place the hedge + Expected basis at delivery – Broker commission

6. Short Hedge Example  As of Jan. 16, ($ per bushel) Nov. 2015 soybean futures$ 9.76 Historical basis for Nov.$-0.30 Rough commission on trade$-0.01 Expected price$ 9.45  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

7. Prices Went Up, Hist. Basis  In November, buy back futures at $10.50 per bushel ($ per bushel) Nov. 2015 soybean futures$10.50 Actual basis for Nov.$-0.30 Local cash price$10.20 Net value from futures$-0.75 ($9.76 - $10.50 - $0.01) Net price$ 9.45

8. Prices Went Down, Hist. Basis  In November, buy back futures at $8.00 per bushel ($ per bushel) Nov. 2015 soybean futures$ 8.00 Actual basis for Nov.$-0.30 Local cash price$ 7.70 Net value from futures$ 1.75 ($9.76 - $8.00 - $0.01) Net price$ 9.45

9. Short Hedge Graph Hedging Nov. 2015 Soybeans @ $9.76

10. Prices Went Down, Basis Change  In November, buy back futures at $8.00 per bushel ($ per bushel) Nov. 2015 soybean futures$ 8.00 Actual basis for Nov.$-0.10 Local cash price$ 7.90 Net value from futures$ 1.75 ($9.76 - $8.00 - $0.01) Net price$ 9.65  Basis narrowed, net price improved

11. 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

12. 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

13. 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

14. Long Hedge Expected Price  Expected price = Futures prices when I place the hedge + Expected basis at delivery + Broker commission

15. Long Hedge Example  As of Jan. 16, ($ per bushel) Dec. 2015 corn futures$ 4.15 Historical basis for Dec.$ -0.25 Rough commission on trade$+0.01 Expected local net price$ 3.91  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

16. Prices Went Up, Hist. Basis  In December, sell back futures at $5.00 per bushel ($ per bushel) Dec. 2015 corn futures$ 5.00 Actual basis for Dec.$-0.25 Local cash price$ 4.75 Less net value from futures$-0.84 - ($5.00 - $4.15 - $0.01) Net cost of corn$ 3.91  Futures gained in value, reducing net cost of corn to the plant

17. Prices Went Down, Hist. Basis  In December, sell back futures at $3.00 per bushel ($ per bushel) Dec. 2015 corn futures$ 3.00 Actual basis for Dec.$ -0.25 Local cash price$ 2.75 Less net value from futures$+1.16 - ($3.00 - $4.15 - $0.01) Net cost of corn$ 3.91  Futures lost value, increasing net cost of corn

18. Long Hedge Graph Hedging Dec. 2015 Corn @ $4.15

19. Prices Went Down, Basis Change  In December, sell back futures at $3.00 per bushel ($ per bushel) Dec. 2014 corn futures$ 3.00 Actual basis for Dec.$ -0.10 Local cash price$ 2.90 Less net value from futures$+1.16 - ($3.00 - $4.15 - $0.01) Net cost of corn$ 4.06  Basis narrowed, net cost of corn increased

20. 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

21. Class web site: http://www.econ.iastate.edu/~chart/Classes/econ337/ Spring2015/ Have a great weekend!