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Using Futures

Using Futures. Commodity Marketing Activity Chapter #4. 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. Futures.

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Using Futures

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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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