Provide a brief review of futures. Carefully review alternative market
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2 Provide a brief review of futures markets. Carefully review alternative market conditions i and which h marketing strategies work best under alternative conditions. Have an open and interactive discussion!!
3 ACTION 1. Store or Wait to Forward Contract 2. Delayed Pricing Contract 3. Minimum Price Hedged-to-Arrive (HTA) BASIS STRENGTHENS ACTION 1. Hedge (Sell ) 2. Hedged-to-Arrive (HTA) Contract 3. Buy Put Option UP FUTURES EXPECTED CHANGE FOR FUTURES AND BASIS FUTURES DOWN John Ferris Michigan State University ACTION 1. Basis Contract 2. Minimum Price Contract 3. Sell (or Forward Contract) and Buy Calls 4. Sell (or Forward Contract) t) and Buy ACTION 1. Sales 2. Forward Contract BASIS WEAKENS
4 The key to choosing the correct marketing kti tool (results in the highest h local cash price) is to understand: 1) The expected trends in futures prices 2) The expected trends in basis
5
6 A contract to deliver a specific quantity of grain (5,000 bu. of Hard Red Spring Wheat) with a specific quality standard (# 2 Northern Spring with min. of 13.5 % pro.) to a specific location (Minneapolis/St. Paul) by a specific date (before 15 th of contract month).
7 Delivery months for Hard Red Spring Wheat on Minneapolis Grain Exchange: September December March May July
8 Delivery months for Corn on Chicago Board of Trade: December March May July September
9 Delivery months for Soybeans on Chicago Board of Trade: November, January March, May July, August September
10 PRICE is the only contract provision that is negotiable. Remember, for every seller there must be a buyer; and, for every buyer there must be a seller.
11 You can buy a contract or sell a contract without t owning any commodity. The contract is an agreement to deliver in the future. Contracts are rarely fully executed (physical deliver made), the are off set.
12 Every trading day, a price is negotiated for the delivery of the specific commodity (Hard Red Spring Wheat) at different times in the future. The near by futures month is the one closest to today s date.
13 Mpls. HRSW & Minot Price l Price per Bushe Minot July 480 Sep 460 Dec Mar 440 May Dec 06 Jan 07 Feb 07 Mar 07 Apr 07 May 07 Jun 07
14 There is a strong relationship, although not perfect, between the futures contract and the cash trading of the same commodity. The futures price is also commonly used as a proxy for a national average price.
15 The local physical delivery of grain for sale today. Local sale price is influenced by: Grain dealer s cost structure (margins) Local competition (supply & demand) Transportation to processor or terminal market Ti diff b h d Time differences between purchase and processing or re selling (storage & interest)
16 The difference between the cash price and the futures price (cash price futures price) is the basis, and is unique to each local cash market. NOTE: A basis value can be calculated between different trading months for the same commodity or across different commodity exchanges (ex. Minneapolis vs. Chicago).
17 Mpls. HRSW & Minot Price l Price per Bushe Minot July 480 Sep 460 Dec Mar 440 May Dec 06 Jan 07 Feb 07 Mar 07 Apr 07 May 07 Jun 07
18 Nearby Spring Wheat Basis for Minot er Bushel Dec 06 Jan 07 Feb 07 Mar 07 Apr 07 May 07 Jun Nearby Basis Price p
19 When is the local basis typically the widest (biggest difference between cash and futures prices)? When is the local basis typically the narrowest (smallest difference between cash and futures prices)?
20 Grain dealers, like the local elevator, use the futures market kt to reduce risk. ik Farmers and processors can use futures markets to establish a base price for a commodity without having to actually deliver or receive the commodity (establish a price for future delivery).
21 Allows grain dealers and processors to offer more sophisticated t cash marketing kti contracts to farmers: Hedge To Arrive ( Fixed) Contract Basis Fixed Contract Minimum Price Contract Dl Delayed Price Contract t
22 The key to choosing the correct marketing kti tool (results in the highest h local cash price) is to understand: 1) The expected trends in futures prices 2) The expected trends in basis
23 ACTION 1. Store or Wait to Forward Contract 2. Delayed Pricing Contract 3. Minimum Price Hedged-to-Arrive (HTA) BASIS STRENGTHENS ACTION 1. Hedge (Sell ) 2. Hedged-to-Arrive (HTA) Contract 3. Buy Put Option UP FUTURES EXPECTED CHANGE FOR FUTURES AND BASIS FUTURES DOWN John Ferris Michigan State University ACTION 1. Basis Contract 2. Minimum Price Contract 3. Sell (or Forward Contract) and Buy Calls 4. Sell (or Forward Contract) t) and Buy ACTION 1. Sales 2. Forward Contract BASIS WEAKENS
24 ACTION 1. Store or Wait to Forward Contract 2. Delayed Pricing Contract 3. Minimum Price Hedged-to-Arrive (HTA) BASIS STRENGTHENS ACTION 1. Hedge (Sell ) 2. Hedged-to-Arrive (HTA) Contract 3. Buy Put Option UP FUTURES EXPECTED CHANGE FOR FUTURES AND BASIS FUTURES DOWN John Ferris Michigan State University ACTION 1. Basis Contract 2. Minimum Price Contract 3. Sell (or Forward Contract) and Buy Calls 4. Sell (or Forward Contract) t) and Buy ACTION 1. Sales 2. Forward Contract BASIS WEAKENS
25 Farmer delivers grain today, but cash price is not established tblihd until a future date. Title for grain is transferred to the buyer, and buyer commonly resells grain before final cash price is established.
26 Seller is unsecured creditor, but grain dealers bonding applies for first 30 days of contract. The grain dealers bond may or may not apply after 30 days. N.D. Credit Sale Contract Indemnity fund covers 80% of value for contracts over 30 days.
27 The futures price is not established. The basis is not established. tblihd The grain buyer typically y charges a fee to write a Delayed Pricing Contract, which covers a portion of the basis risk.
28 Grain buyer purchases a Call Option and writes a forward contract with the farmer. This establishes a minimum i futures price for the cash sale in the future. The basis has NOT been established. The premium for the Call Option is part of the contract fees.
29 The buyer of a Call Option gains money when the futures price goes UP. The buyer of a Put Option gains money when the futures price goes DOWN. A NET PROFIT is not made until the price movement is more than the premium paid for the option.
30 How could a farmer implement this type of options strategy t without t using a Minimum Price Hedge to Arrive contract?
31 ACTION 1. Store or Wait to Forward Contract 2. Delayed Pricing Contract 3. Minimum Price Hedged-to-Arrive (HTA) BASIS STRENGTHENS ACTION 1. Hedge (Sell ) 2. Hedged-to-Arrive (HTA) Contract 3. Buy Put Option UP FUTURES EXPECTED CHANGE FOR FUTURES AND BASIS FUTURES DOWN John Ferris Michigan State University ACTION 1. Basis Contract 2. Minimum Price Contract 3. Sell (or Forward Contract) and Buy Calls 4. Sell (or Forward Contract) t) and Buy ACTION 1. Sales 2. Forward Contract BASIS WEAKENS
32 This is a contract between a grain buyer and farmer where the basis is specified in the contract, but the futures price has NOT been established. The farmer can choose the futures price at a later date (time of final sale).
33 The grain buyer purchases a Call Option and writes a forward contract with the farmer. This establishes a minimum i cash price for the cash sale in the future. The basis IS specified in the contract. The option premium is included as a cost within the contract.
34 Reminder, the buyer of a Call Option makes money when the futures price increases. A Net Gain is realized when the price increase is greater than the cost of the option. Why does this strategy work?
35 Why does this strategy work? Is this more risky than storing cash grain and waiting for a price increase? Is this more risky than a minimum price contract or sell cash buy call strategy?
36 ACTION 1. Store or Wait to Forward Contract 2. Delayed Pricing Contact 3. Minimum Price Hedged-to-Arrive (HTA) BASIS STRENGTHENS ACTION 1. Hedge (Sell ) 2. Hedged-to-Arrive (HTA) Contract 3. Buy Put Option UP FUTURES EXPECTED CHANGE FOR FUTURES AND BASIS FUTURES DOWN John Ferris Michigan State University ACTION 1. Basis Contract 2. Minimum Price Contract 3. Sell (or Forward Contract) and Buy Calls 4. Sell (or Forward Contract) t) and Buy ACTION 1. Sales 2. Forward Contract BASIS WEAKENS
37 Hedge taking an opposite position in the cash and futures markets. kt Ex. Sell Buy Ex. Buy Sell Why does this strategy work?
38 This is a also called a Fixed Contract. t The grain buyer purchases a futures contract to set the base price, but the basis has NOT been determined. The basis is usually determined at the time of final sale.
39 When does the buyer of a put option make money? When does the buyer of a put option make a net gain? Why does this strategy work?
40 ACTION 1. Store or Wait to Forward Contract 2. Delayed Pricing Contract 3. Minimum Price Hedged-to-Arrive (HTA) BASIS STRENGTHENS ACTION 1. Hedge (Sell ) 2. Hedged-to-Arrive (HTA) Contract 3. Buy Put Option UP FUTURES EXPECTED CHANGE FOR FUTURES AND BASIS FUTURES DOWN John Ferris Michigan State University ACTION 1. Basis Contract 2. Minimum Price Contract 3. Sell (or Forward Contract) and Buy Calls 4. Sell (or Forward Contract) t) and Buy ACTION 1. Sales 2. Forward Contract BASIS WEAKENS
41 All of these strategies assume that you have a relatively strong opinion about what direction prices will move (both futures and cash). Following a strong trend line is easy; picking the turns is hard. A large part of marketing strategies is also risk management.
42 A good risk management strategy tests: What would happen if I made the wrong decision? Can I absorb the results of a wrong decision? Do the benefits of the risk management strategy out weight the costs?
43 Knowing when to use the appropriate marketing tool can py pay big dividends. Unfortunately, not all the crops grown in the Northern Plains have futures markets. This does not eliminate forward pricing opportunities, it just limits the available tools.
44 Frayne Olson Dept. of Agribusiness & Applied Econ. NDSU Dept P.O. Box 6050 Fargo, ND frayne.olson@ndsu.edu d
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