econ 337: agricultural marketing chad hart associate professor [email protected] 515-294-9911 lee...
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ECON 337:Agricultural Marketing
Chad HartAssociate [email protected]
Lee SchulzAssistant [email protected]
Market ParticipantsHedgers are willing to make or take physical
delivery because they are producers or users of the commodity Use futures to protect against a price movementCash and futures prices are highly correlatedHold counterbalancing positions in the two
markets to manage the risk of price movement
HedgersFarmers, livestock producers Merchandisers, elevators Food processors, feed manufacturers Exporters Importers
What happens if futures market is restricted to only hedgers?
Market ParticipantsSpeculators have no use for the physical
commodityThey buy or sell in an attempt to profit from price
movementsAdd liquidity to the market
May be part of the general public, professional traders or investment managersShort-term – “day traders”Long-term – buy or sell and hold
Market Participants
Brokers exercise trade for traders and are paid a flat fee called a commission
Futures are a “zero sum game”Losers pay winnersBrokers always get paid commission
Hedging
Holding equal and opposite positions in the cash and futures markets
The substitution of a futures contract for a later cash-market transaction
Who can hedge?Farmers, merchandisers, elevators,
processors, exporter/importers
Cash vs. Futures PricesIowa Corn in 2013
Short HedgersProducers with a commodity to sell at
some point in the futureAre hurt by a price decline
Sell the futures contract initially
Buy the futures contract (offset) when they sell the physical commodity
Short Hedge ExampleA 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
Short Hedge ExampleTo create an equal and opposite position, the
producer would sell 5 November soybean futures contractsEach contract is for 5,000 bushelsThe farmer would short the futures, opposite their
long from production
As prices increase (decline), the futures position loses (gains) value
Short Hedge Expected Price
Expected price =
Futures prices when I place the hedge
+ Expected basis at delivery
– Broker commission
Short Hedge Example As of Jan. 21,
($ per bushel)
Nov. 2014 soybean futures $11.09
Historical basis for Nov. $-0.30
Rough commission on trade $-0.01
Expected price $10.78
Come November, the producer is ready to sell soybeansPrices could be higher or lowerBasis could be narrower or wider than the historical
average
Prices Went Up, Hist. Basis In November, buy back futures at $12.00 per
bushel($ per bushel)
Nov. 2014 soybean futures $12.00
Actual basis for Nov. $-0.30
Local cash price$11.70
Net value from futures $-0.92
($11.09 - $12.00 - $0.01)
Net price$10.78
Prices Went Down, Hist. Basis In November, buy back futures at $10.00 per
bushel($ per bushel)
Nov. 2014 soybean futures $10.00
Actual basis for Nov. $-0.30
Local cash price $ 9.70
Net value from futures $ 1.08
($11.09 - $10.00 - $0.01)
Net price$10.78
Short Hedge Graph
Hedging Nov. 2014 Soybeans @ $11.09
Prices Went Down, Basis Change In November, buy back futures at $10.00 per bushel
($ per bushel)
Nov. 2014 soybean futures $10.00
Actual basis for Nov. $-0.10
Local cash price $ 9.90
Net value from futures $ 1.08
($11.09 - $10.00 - $0.01)
Net price $10.98
Basis narrowed, net price improved
Long HedgersProcessors or feeders that plan to buy a
commodity in the futureAre hurt by a price increase
Buy the futures initially
Sell the futures contract (offset) when they buy the physical commodity
Long Hedge ExampleAn ethanol plant will buy 50,000 bushels of
corn in December
The long hedge is to protect the ethanol plant from rising corn prices between now and December
Since the plant is using the corn, they are considered short in corn
Long Hedge ExampleTo create an equal and opposite position, the
plant manager would buy 10 December corn futures contractsEach contract is for 5,000 bushelsThe plant manager would long the futures,
opposite their short from usage
As prices increase (decline), the futures position gains (loses) value
Long Hedge Expected Price
Expected price =
Futures prices when I place the hedge
+ Expected basis at delivery
+ Broker commission
Long Hedge Example As of Jan. 21,
($ per bushel)
Dec. 2014 corn futures $ 4.47
Historical basis for Dec. $ -0.25
Rough commission on trade $+0.01
Expected local net price $ 4.23
Come December, the plant manager is ready to buy corn to process into ethanolPrices could be higher or lowerBasis could be narrower or wider than the historical
average
Prices Went Up, Hist. Basis In December, sell back futures at $5.00 per bushel
($ per bushel)
Dec. 2014 corn futures $ 5.00
Actual basis for Dec. $-0.25
Local cash price $ 4.75
Less net value from futures $-0.52
-($5.00 - $4.47 - $0.01)
Net cost of corn $ 4.23
Futures gained in value, reducing net cost of corn to the plant
Prices Went Down, Hist. Basis In December, sell back futures at $3.00 per bushel
($ per bushel)
Dec. 2014 corn futures $ 3.00
Actual basis for Dec. $ -0.25
Local cash price $ 2.75
Less net value from futures $+1.48
-($3.00 - $4.47 - $0.01)
Net cost of corn $ 4.23
Futures lost value, increasing net cost of corn
Long Hedge GraphHedging Dec. 2014 Corn @ $4.47
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 $+1.48
-($3.00 - $4.47 - $0.01)
Net cost of corn $ 4.38
Basis narrowed, net cost of corn increased
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
Class web site:http://www.econ.iastate.edu/~chart/Classes/econ337/Spring2014/
Lab in Heady 68!