Provide a brief review of futures markets. Carefully review alternative market conditions and which marketing
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1 Provide a brief review of fuures markes. Carefully review alernaive marke condiions and which markeing sraegies work bes under alernaive condiions. Have an open and ineracive discussion!! 1. Sore or Wai o Forward Conrac 2. Delayed Pricing Conrac 3. Minimum Price Hedged-o-Arrive 1. Hedge (Sell ) 2. Hedged-o-Arrive d Conrac 3. Buy Pu Opion 3. Sell (or Forward Conrac) 4. Sell (or Forward Conrac) and Buy 1. Sales 2. Forward dconrac The key o choosing he correc markeing ool (resuls in he highes local cash price) is o undersand: 1) The expeced rends in fuures prices 2) The expeced rends in basis 1
2 A conrac o deliver a specific quaniy of grain (5,000 bu. of Hard Red Spring Whea) wih a specific qualiy sandard (# 2 Norhern Spring wih min. of 13.5 % pro.) o a specific locaion (Minneapolis/S. Paul) by a specific dae (before 15 h of conrac monh). Delivery monhs for Hard Red Spring Whea on Minneapolis Grain Exchange: Sepember December March May July Delivery monhs for Corn on Chicago Board of Trade: December March May July Sepember 2
3 Delivery monhs for Soybeans on Chicago Board of Trade: November, January March, May July, Augus Sepember PRICE is he only conrac provision ha is negoiable. Remember, for every seller here mus be a buyer; and, for every buyer here mus be a seller. You can buy a conrac or sell a conrac wihou owning any commodiy. The conrac is an agreemen o deliver in he fuure. Conracs are rarely fully execued (physical deliver made), he are off se. Every rading day, a price is negoiaed for he delivery of he specific commodiy (Hard Red Spring Whea) a differen imes in he fuure. The near by fuures monh is he one closes o oday s dae. 3
4 Mpls. HRSW & Mino Price Price per Bushel Mino July Sep Dec Mar May There is a srong relaionship, alhough no perfec, beween he fuures conrac and he cash rading of he same commodiy. The fuures price is also commonly used as a proxy for a naional average price. Dec 06 Jan 07 Feb 07 Mar 07 Apr 07 May 07 Jun 07 The local physical delivery of grain for sale oday. Local sale price is influenced by: Grain dealer s cos srucure (margins) Local compeiion (supply & demand) Transporaion o processor or erminal marke Time differences beween purchase and processing or re selling (sorage & ineres) The difference beween he cash price and he fuures price (cash price fuures price) is he basis, and is unique o each local cash marke. NOTE: A basis value can be calculaed beween differen rading monhs for he same commodiy or across differen commodiy exchanges (ex. Minneapolis vs. Chicago). 4
5 Mpls. HRSW & Mino Price Nearby Spring Whea Basis for Mino 10 Price per Bushel Mino July Sep Dec Mar May Price per Bushel Dec Dec 06 Jan 07 Feb 07 Mar 07 Apr 07 Jan 07 May 07 Feb 07 Mar 07 Apr 07 Jun 07 May 07 Jun 07 Nearby Basis When is he local basis ypically he wides (bigges difference beween cash and fuures prices)? When is he local basis ypically he narrowes (smalles difference beween cash and fuures prices)? Grain dealers, like he local elevaor, use he fuures marke o reduce risk. Farmers and processors can use fuures markes o esablish a base price for a commodiy wihou having o acually deliver or receive he commodiy (esablish a price for fuure delivery). 5
6 Allows grain dealers and processors o offer more sophisicaed cash markeing conracs o farmers: Hedge To Arrive ( Fixed) Conrac Basis Fixed Conrac Minimum Price Conrac Delayed Price Conrac The key o choosing he correc markeing ool (resuls in he highes local cash price) is o undersand: 1) The expeced rends in fuures prices 2) The expeced rends in basis 1. Sore or Wai o Forward Conrac 2. Delayed Pricing Conrac 3. Minimum Price Hedged-o-Arrive 3. Sell (or Forward Conrac) 4. Sell (or Forward Conrac) and Buy 1. Sore or Wai o Forward Conrac 2. Delayed Pricing Conrac 3. Minimum Price Hedged-o-Arrive 3. Sell (or Forward Conrac) 4. Sell (or Forward Conrac) and Buy 1. Hedge (Sell ) 2. Hedged-o-Arrive d Conrac 3. Buy Pu Opion 1. Sales 2. Forward dconrac 1. Hedge (Sell ) 2. Hedged-o-Arrive d Conrac 3. Buy Pu Opion 1. Sales 2. Forward dconrac 6
7 Farmer delivers grain oday, bu cash price is no esablished unil a fuure dae. Tile for grain is ransferred o he buyer, and buyer commonly resells grain before final cash price is esablished. Sll Seller is unsecured credior, bu grain dealers bonding applies for firs 30 days of conrac. The grain dealers bond may or may no apply afer 30 days. N.D. Credi Sale Sl Conrac Indemniy fund covers 80% of value for conracs over 30 days. The fuures price is no esablished. blihd The basis is no esablished. The grain buyer ypically charges a fee o wrie a Delayed Pricing Conrac, which covers a porion of he basis risk. Grain buyer purchases a Call Opion and wries a forward conrac wih he farmer. This esablishes a minimum fuures price for he cash sale in he fuure. The basis has NOT been esablished. The premium for he Call Opion is par of he conrac fees. 7
8 The buyer of a Call Opion gains money when he fuures price goes. The buyer of a Pu Opion gains money when he fuures price goes. A NET PROFIT is no made unil he price movemen is more han he premium paid for he opion. How could a farmer implemen his ype of opions sraegy wihou using a Minimum Price Hedge o Arrive conrac? 1. Sore or Wai o Forward Conrac 2. Delayed Pricing Conrac 3. Minimum Price Hedged-o-Arrive 1. Hedge (Sell ) 2. Hedged-o-Arrive d Conrac 3. Buy Pu Opion 3. Sell (or Forward Conrac) 4. Sell (or Forward Conrac) and Buy 1. Sales 2. Forward dconrac This is a conrac beween a grain buyer and farmer where he basis is specified in he conrac, bu he fuures price has NOT been esablished. The farmer can choose he fuures price a a laer dae (ime of final sale). 8
9 The grain buyer purchases a Call Opion and wries a forward conrac wih he farmer. This esablishes a minimum cash price for he cash sale in he fuure. The basis IS specified in he conrac. The opion premium is included as a cos wihin he conrac. Reminder, he buyer of a Call Opion makes money when he fuures price increases. A Ne Gain is realized when he price increase is greaer han he cos of he opion. Why does his sraegy work? Why does his sraegy work? Is his more risky han soring cash grain and waiing for a price increase? Is his more risky han a minimum price conrac or sell cash buy call sraegy? 1. Sore or Wai o Forward Conrac 2. Delayed Pricing Conac 3. Minimum Price Hedged-o-Arrive 1. Hedge (Sell ) 2. Hedged-o-Arrive d Conrac 3. Buy Pu Opion 3. Sell (or Forward Conrac) 4. Sell (or Forward Conrac) and Buy 1. Sales 2. Forward dconrac 9
10 Hedge aking an opposie posiion in he cash and fuures markes. Ex. Sell Buy Ex. Buy Sell Why does his sraegy work? This is a also called a Fixed Conrac. The grain buyer purchases a fuures conrac o se he base price, bu he basis has NOT been deermined. The basis is usually deermined a he ime of final sale. When does he buyer of a pu opion make money? When does he buyer of a pu opion make a ne gain? Why does his sraegy work? 1. Sore or Wai o Forward Conrac 2. Delayed Pricing Conrac 3. Minimum Price Hedged-o-Arrive 1. Hedge (Sell ) 2. Hedged-o-Arrive d Conrac 3. Buy Pu Opion 3. Sell (or Forward Conrac) 4. Sell (or Forward Conrac) and Buy 1. Sales 2. Forward dconrac 10
11 All of hese sraegies assume ha you have a relaively srong opinion abou wha direcion prices will move (boh fuures and cash). Following a srong rend line is easy; picking he urns is hard. A large par of markeing sraegies is also risk managemen. A good risk managemen sraegy ess: Wha would happen if I made he wrong decision? Can I absorb he resuls of a wrong decision? Do he benefis of he risk managemen sraegy ou weigh he coss? Knowing when o use he appropriae markeing ool can pay big dividends. Unforunaely, no all he crops grown in he Norhern Plains have fuures markes. This does no eliminae forward pricing opporuniies, i jus limis he available ools. Frayne Olson Dep. of Agribusiness & Applied Econ. NDSU Dep P.O. Box 6050 Fargo, ND frayne.olson@ndsu.edu 11
Provide a brief review of futures. Carefully review alternative market
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