Basis and Price Formation

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Basis and Price Formation
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Basis

• Basis is the difference between a cash price at a
  specific location and the price of a particular
  futures contract. The cash price offered to a
  grain producer for any given marketing strategy
  is a function of local basis.

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Determination of Basis

• Major Factors
• COST OF STORAGE Determines basis over a given
  crop year. Also affects the price difference
  between a nearby and a distant futures contract
  in a given crop year.
• COST OF TRANSPORTATION Determines basis
  geographically.

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Determination of Basis

• Other Factors
• Local supply and demand conditions
• Grain quality
• Intensity of local competition

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Basis

• Basis Cash-Futures Price ( or Futures - Cash
  Price)
• Calculated From Nearby Futures (Cash - Next
  Futures Contract to Mature)
• Has Predictable Patterns (More Predictable Than
  Cash Prices)
• Not Perfectly Predictable (Basis Risk)
• Determines the Success of Hedge

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Two Types of Basis

• Time Basis
• Cash Price Less Futures Price
• Zero at Contract Maturity
• Location Basis
• Chicago Cash Price Less Your Local Cash Price
• Localizing the Basis

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Strengthening and Weakening Basis
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Typical Grain Basis Pattern
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Predictable Basis Patterns

• Futures gt Cash Prior to Contract Maturity
• Futures Cash Price at Contract Maturity
• Basis Widens Into Harvest
• Basis Narrows During Storage Season
• Futures and Cash Prices Move Together
• Basis is Predictable From Year to Year

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Hedging Principle
The Basis Determines the Success of A Hedge
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Basis and Storage Costs

Futures Price
Cash Price
Basis
Storage Costs
P harvest
Fall Harvest
Spring
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Corn Storage Hedge
Date Cash Market
Futures Market
October Harvest Price 3.00 Sell July
Fut. 3.50
Est. June Basis .10
Storage Cost .30
Forward Price 3.50-.10 3.40
Storage Profit 3.40 -3.00 - .30 .10
June Cash Sale _at_ 3.30 Buy Back
Fut. _at_ 3.40
Return to Hedge 3.30 .10 3.40
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Recording Basis
To record historical basis levels, collect
closing futures prices for the contract closest
to maturity (but not expiring in the current
month) each Wednesday, and the corresponding cash
price (collected later Wednesday or Thursday
morning). Subtract the futures price from the
cash price. Average the Wednesday basis
calculations for each month to arrive at the
average monthly basis level.
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Finding Local Basis Information

• Compile it yourself over several years.
• Contact you local county extension office.
• Contact your local grain brokers, lenders, market
  advisory services.