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Futures Contract Marketing Strategies: Hedging Techniques and Risk Management

Learn about futures contracts and hedging strategies in commodity marketing activities. Understand how to use futures contracts to hedge against price fluctuations and manage risks effectively in the market.

jillian-camacho
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Futures Contract Marketing Strategies: Hedging Techniques and Risk Management

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  1. Using Futures Commodity Marketing Activity Chapter #4

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

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

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

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

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

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

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

  9. Hedges • If Basis strengthens: Cash=2.30 Fut=2.55 BasisFuture $Cash $Fut GnNet -.152.25 2.10 .30 2.40 -.10 2.25 2.15 .30 2.45 -.15 2.90 2.75 -.35 2.40 -.10 2.90 2.80 -.35 2.45 • Protected when price fell, didn’t see the profit when prices went up

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

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

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

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

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

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

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

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