ECON 337:

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ECON 337 Agricultural Marketing

Chad Hart Associate Professor chart_at_iastate.edu 51
5-294-9911
Lee Schulz Assistant Professor lschulz_at_iastate.edu
515-294-3356
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Short Hedgers

• Producers with a commodity to sell at some point
  in the future
• Are hurt by a price decline
• Sell the futures contract initially
• Buy the futures contract (offset) when they sell
  the physical commodity

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Short Hedge Example

• A soybean producer will have 25,000 bushels to
  sell in November
• The short hedge is to protect the producer from
  falling prices between now and November
• Since the farmer is producing the soybeans, they
  are considered long in soybeans

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Short Hedge Example

• To create an equal and opposite position, the
  producer would sell 5 November soybean futures
  contracts
• Each contract is for 5,000 bushels
• The farmer would short the futures, opposite
  their long from production
• As prices increase (decline), the futures
  position loses (gains) value

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Short Hedge Expected Price

• Expected price
• Futures prices when I place the hedge
• Expected basis at delivery
• Broker commission

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Short Hedge Example

• As of Jan. 16,
• ( per bushel)
• Nov. 2015 soybean futures 9.76
• Historical basis for Nov. -0.30
• Rough commission on trade -0.01
• Expected price 9.45
• Come November, the producer is ready to sell
  soybeans
• Prices could be higher or lower
• Basis could be narrower or wider than the
  historical average

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Prices Went Up, Hist. Basis

• In November, buy back futures at 10.50 per
  bushel
• ( per bushel)
• Nov. 2015 soybean futures 10.50
• Actual basis for Nov. -0.30
• Local cash price 10.20
• Net value from futures -0.75
• (9.76 - 10.50 - 0.01)
• Net price 9.45

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Prices Went Down, Hist. Basis

• In November, buy back futures at 8.00 per bushel
• ( per bushel)
• Nov. 2015 soybean futures 8.00
• Actual basis for Nov. -0.30
• Local cash price 7.70
• Net value from futures 1.75
• (9.76 - 8.00 - 0.01)
• Net price 9.45

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Short Hedge Graph
Hedging Nov. 2015 Soybeans _at_ 9.76
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Prices Went Down, Basis Change

• In November, buy back futures at 8.00 per bushel
• ( per bushel)
• Nov. 2015 soybean futures 8.00
• Actual basis for Nov. -0.10
• Local cash price 7.90
• Net value from futures 1.75
• (9.76 - 8.00 - 0.01)
• Net price 9.65
• Basis narrowed, net price improved

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Long Hedgers

• Processors or feeders that plan to buy a
  commodity in the future
• Are hurt by a price increase
• Buy the futures initially
• Sell the futures contract (offset) when they buy
  the physical commodity

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Long Hedge Example

• An ethanol plant will buy 50,000 bushels of corn
  in December
• The long hedge is to protect the ethanol plant
  from rising corn prices between now and December
• Since the plant is using the corn, they are
  considered short in corn

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Long Hedge Example

• To create an equal and opposite position, the
  plant manager would buy 10 December corn futures
  contracts
• Each contract is for 5,000 bushels
• The plant manager would long the futures,
  opposite their short from usage
• As prices increase (decline), the futures
  position gains (loses) value

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Long Hedge Expected Price

• Expected price
• Futures prices when I place the hedge
• Expected basis at delivery
• Broker commission

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Long Hedge Example

• As of Jan. 16,
• ( per bushel)
• Dec. 2015 corn futures 4.15
• Historical basis for Dec. -0.25
• Rough commission on trade 0.01
• Expected local net price 3.91
• Come December, the plant manager is ready to buy
  corn to process into ethanol
• Prices could be higher or lower
• Basis could be narrower or wider than the
  historical average

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Prices Went Up, Hist. Basis

• In December, sell back futures at 5.00 per
  bushel
• ( per bushel)
• Dec. 2015 corn futures 5.00
• Actual basis for Dec. -0.25
• Local cash price 4.75
• Less net value from futures -0.84
• -(5.00 - 4.15 - 0.01)
• Net cost of corn 3.91
• Futures gained in value, reducing net cost of
  corn to the plant

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Prices Went Down, Hist. Basis

• In December, sell back futures at 3.00 per
  bushel
• ( per bushel)
• Dec. 2015 corn futures 3.00
• Actual basis for Dec. -0.25
• Local cash price 2.75
• Less net value from futures 1.16
• -(3.00 - 4.15 - 0.01)
• Net cost of corn 3.91
• Futures lost value, increasing net cost of corn

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Long Hedge Graph
Hedging Dec. 2015 Corn _at_ 4.15
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Prices Went Down, Basis Change

• In December, sell back futures at 3.00 per
  bushel
• ( per bushel)
• Dec. 2014 corn futures 3.00
• Actual basis for Dec. -0.10
• Local cash price 2.90
• Less net value from futures 1.16
• -(3.00 - 4.15 - 0.01)
• Net cost of corn 4.06
• Basis narrowed, net cost of corn increased

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Hedging Results

• In a hedge the net price will differ from
  expected price only by the amount that the actual
  basis differs from the expected basis.
• So basis estimation is critical to successful
  hedging.
• Narrowing basis, good for short hedgers, bad for
  long hedgers
• Widening basis, bad for short hedgers, good for
  long hedgers

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• Class web site
• http//www.econ.iastate.edu/chart/Classes/econ337
  /Spring2015/
• Have a great weekend!