Basis and Price Formation

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.

Basis Changes

• The lower the cash price relative to futures prices, the weaker the basis. A weak basis is good for cash buyers,and bad for cash sellers

• The higher the cash price is relative to futures, the stronger the basis. A strong basis is bad for cash buyers,and good for cash sellers.

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.

Determination of Basis

Other Factors:

• Local supply and demand conditions

• Grain quality

• Intensity of local Competition

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.

Odessa Washington White Wheat Basis

Jul Aug Sep Oct Nov Dec Jan Feb2008/09 -$0.71 -$0.41 -$0.80 -$0.85 -$0.50 -$0.86 -$0.48 -$0.21

Sep 2009/10 -$0.41 -$0.40 -$0.62 -$0.82 -$1.09 -$0.92 -$0.81 -$0.72Oct 2010/11 -$1.32 -$0.96 -$1.21 -$1.22 -$0.85 -$0.86 -$0.70 -$0.61

Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

2008/09 -$0.71 -$0.41 -$0.80 -$0.85 -$0.50 -$0.86 -$0.48 -$0.21 -$0.32 -$0.57 -$0.60 -$0.23

2009/10 -$0.41 -$0.40 -$0.62 -$0.82 -$1.09 -$0.92 -$0.81 -$0.72 -$0.65 -$0.61 -$0.54 -$0.60

2010/11 -$1.32 -$0.96 -$1.21 -$1.22 -$0.85 -$0.86 -$0.70 -$0.61 -$0.67 -$0.43 -$0.47 -$0.13

2011/12 -$0.51 -$0.72 -$0.74 -$0.66 -$0.73 -$0.75 -$0.37

Average -$0.74 -$0.69 -$0.86 -$0.96 -$0.82 -$0.88 -$0.66 -$0.51 -$0.55 -$0.54 -$0.54 -$0.32

Using basis information to evaluate a storage decision.

January 15, 2000Today's cash price $4.75

March futures price $5.23May futures price $5.32July futures price $5.41

Expected cash prices for later delivery on January 15:

Store Until: February March April May June

Futures Price $5.23 $5.32 $5.23 $5.41 $5.41Expected Basis -$0.30 -$0.31 -$0.29 -$0.26 -$0.27Expected Cash Price $4.93 $5.01 $5.03 $5.15 $5.14

Storage ReturnExpected Cash Price $4.93 $5.01 $5.03 $5.15 $5.14minus Today's Price $4.75 $4.75 $4.75 $4.75 $4.75minus Storage Costs* $0.035 $0.07 $0.105 $0.14 $0.175Total Return $0.15 $0.19 $0.18 $0.26 $0.22Per Month Return $0.15 $0.095 0.058$ $0.065 $0.043

* Storage costs are 3.5 cents per month.