(Lecture notes for the Week 2 Second Session, Wednesday, 2/19/14) Introductory Pricing/Marketing Workshop for Grains, On-Line

Review

Breakeven Basis

First four pricing tools

Continue with

With three more pricing tools

New

Begin Commodity Options

Breakeven Basis, when do you lift a Hedge?

Break-Even Basis Line helps us answer two questions.

1) Should we hedge? a. Basis needs to be weaker than the B-E Basis Line to consider hedging.

2) When to get out of/lift the hedge? a. When basis strengthens to B-E Basis, consider lifting hedge.

3) When a hedge would no longer pay, consider lifting yours.

3) When a hedge would no longer pay, consider lifting yours.

CBOT CORN Mason, MI

Mon Price Chg Delivery Basis Cash

Mar 14 445'2s 4'6 FEB 2014 -0.40 4.05

Mar 14 445'2s 4'6 MAR 2014 -0.38 4.07

Jul 14 455'0s 4'0 JUN 2014 -0.30 4.25

Dec 14 459'6s 3'4 O/N 2014 -0.50 4.10

HEDGE(Hedge‐to‐Arrive)

PricesUp

PricesDown

(FuturesMonth) (Buy) (Buy)ActualBasis

CashPrice PlusNetReturnsfromFuturesSellandBuy

Less: StorageCost BrokerageCost EqualNetReturns EqualsNetPriceReceived

(FuturesMonth) (Sell)ExpectedBasis

StorageCosts

BrokerageCosts

NetExpectedPrice

BASIS CONTRACT (Futures Month) (Price) Less: Cash Price

(Deliver Cash) Basis Contract ____________

Prices Up Prices Down (Futures Month) (Price) (Price) Less: Basis Contract Equals Net Price Received

SELL CASH and BUY FUTURES

SELL CASH and BUY FUTURES (Futures Month) (Buy) Cash Price

(Sell) Actual Basis

Prices Up Prices Down (Futures Month) (Sell) (Sell)

Cash Price Plus Net Returns from

Futures Buy and Sell

Less: Brokerage Cost Equals Net Price Received Actual Basis

Problem, the basis is predictable, prices are generally not

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INSURANCE

Substitution of a small but

certain loss (insurance premium)

for the possibility of. a large .

uncertain loss.

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COMMODITY OPTIONS

MARKET

Market in which producers may

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Purchase right in options market by a remium

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- sell for higher price

.If price is below $3.00

- "collect on policy"

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.CALL OPTION .

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PUT·' OPTION

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.PREMIUMS·

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FUTURES PRICE/

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PORTION OF OPTION pREMIUM

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USl»LLY T~ME VALUE DECREASES;.'~~~'

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MONEY FLOWSHolding a soybean $7.00 putpurchasec

for a $0. 15 premium

OFFSETCurrent futures price is $6.50 .

Sell option at a $0.60 premium

.RESULT

Offset premium received

- Original premium paid

Net returns

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....0.15

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MONEY.·FLOWS.

.Holding a soybean $7.00 put purchased

for a $0.15 premium

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.Current futures price' is $,6.50

Receive a short ·(sell) futures market

.position at $7.00". . "<. ~ ".

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Buy futures at $6.50 '>

RESULT

Futures gain

- Original premium paid .

Net· Returns

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'$0::35."'.