1. Using Futures Commodity Marketing Activity Chapter #4

2. What is a Futures Contract? n Standardized agreement to buy or sell a commodity at a date in the future n Commodity to be delivered n Quantity n Quality n Delivery Point n Delivery Date

3. Futures n As the delivery month approaches, futures price tend to fall in line with cash market prices n Anyone may buy or sell futures through brokers n Obligation to take delivery on a purchased contract is removed by sell before delivery (Offsetting) n Visa Versa

4. Hedging n Buying or selling futures contracts as protection against the risk of loss due to changing prices in cash market n Protection against falling wheat market or rising feed cost n Short Hedge: plan to sell a commodity n Long Hedge: plan to buy a commodity

5. What is Basis? n Relationship between local cash market and futures market price n Basis = cash $ - futures $ n a negative number is under n a positive number is over

6. Short Hedge n Corn Dec. Forward cash market is $2.30 n Dec. Future price is $2.55 n Basis is 25 cents under n Sell Dec. Corn Future n In Dec. Corn market price is $2.00, Futures price is $2.25 (25 cents under) n buy back futures contract at $2.25, sell corn for $2.00

7. Short Hedge n Sell Future $2.55 n Buy Future$2.25 n Profit =$0.30 n Dec Forward $2.30 n Dec Cash$2.00 n Loss =$0.30 n You get $2.00 on cash market plus $.30 from futures = $2.30

8. What if prices go up? n Sell Future $2.55 n Buy Future$2.90 n Loss =$0.35 n Dec Forward $2.30 n Dec Cash$2.65 n Profit =$0.35 n You get $2.65 on cash market minus $.35 from futures = $2.30

9. Hedges n If Basis strengthens: Cash=2.30 Fut=2.55 BasisFuture $Cash $Fut GnNet -.152.252.10.302.40 -.102.252.15.302.45 -.152.902.75 -.352.40 -.102.902.80 -.352.45 n Protected when price fell, didn’t see the profit when prices went up

10. Long Hedge n Same as short hedge for buying inputs n Protection against prices rising n Can’t take advantage of a price decline

11. Margin n Exchange clearing house requires you make a deposit to guarantee possible losses n If prices change significantly, you may have to deposit more money n Contract obligation is Offset when you buy or sell back n Commission charged by brokers for trading contracts

12. Short Hedge Example: n Sept. you plant winter wheat and expect a 20,000 bu crop n you feel that prices are headed down n $500 per contract margin deposit and commission won’t cause you a problem n you sell 4 wheat futures contracts n What price can you expect?

13. Short Hedge Example: n July futures price is $3.60, forward cash price is $3.33 (27 cents under) n based on experience, you expect basis to be about 16 cents under n In July, futures price falls to $3.35, cash price to $3.20 (15 cents under) n you buy back 4 futures contracts at $3.35 (25 cent gain) n sell wheat at $3.20 and get $3.45

14. Short Hedge Example: n Overall gain is 20,000 bu. X’s.25 cents = $5,000 better than cash price n Pay commission of $80/contract

15. Long Hedge Example: n You plant to buy 120 head of feeder cattle in March n In Dec. indications are that prices will rise n You buy 2 feeder cattle futures (88,000#) at $66/cwt n Futures price goes up to $68.90 in Mar., and cash price is $67 n You sell back futures contracts @ $68.90 n Price you pay is $67 minus $2.90 gain in futures market = $64.10

16. Long Hedge Example: n You have reduced your cost by $2,552 from the cash price n minus commission of $75 /contract n should have a definite plan n should have a target price