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ECON 337: Agricultural Marketing

ECON 337: Agricultural Marketing. Lee Schulz Associate Professor lschulz@iastate.edu 515-294-3356. Chad Hart Associate Professor chart@iastate.edu 515-294-9911. Rolling a hedge. Definition To continue to hedge for additional months beyond the expiration of the original contract

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ECON 337: Agricultural Marketing

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  1. ECON 337: Agricultural Marketing Lee Schulz Associate Professor lschulz@iastate.edu 515-294-3356 Chad Hart Associate Professor chart@iastate.edu 515-294-9911

  2. Rolling a hedge • Definition • To continue to hedge for additional months beyond the expiration of the original contract • Done by offsetting original contract • Simultaneously taking new position in a more distant month • The forward price of the hedge is switched to a more distant maturity

  3. Rolling a hedge • When would you do this? • Have storage facilities and flexible cash-flow • See an opportunity to obtain additional returns from storage

  4. Rolling a hedge: Example • Producer is planning to sell corn in December • On June 2nd, he hedges using Dec. futures • Sell Dec. Futures = $2.85/bu • Expected basis for Dec. = -$0.20/bu • Expected spot price at time of maturity • = $2.65/bu ($2.85 – $0.20)

  5. Rolling a hedge: Example • On Nov. 16th • Dec. futures price = $2.38 • Mar. futures price = $2.52 • Dec.-Mar. spread =-$0.14 • Expected basis for Mar. =-$0.15 • Storage costs = $0.03/month

  6. Rolling a hedge: Example • Offset Dec. futures • Buy back Dec. futures for $2.38 • Producer rolls hedge to March • Sell Mar. futures for $2.52 • Stores grain from December to March • Cost to store until March: $0.03 X 3mo = $0.09/bu

  7. Rolling a hedge: Example • Put it all together: • Overall revenue: $2.66 + $0.47 - $0.38 = $2.75

  8. Rolling a hedge: Example • Put it all together: • Overall revenue: $2.66 + $0.47 - $0.38 = $2.75

  9. Rolling a hedge: Example • Put it all together: • Overall revenue: $2.66 + $0.47 - $0.38 = $2.75

  10. Rolling a hedge: Example • Put it all together: • Overall revenue: $2.66 + $0.47 - $0.38 = $2.75

  11. Rolling a hedge: Example • Suppose he didn’t roll the hedge • i.e., he offset his Dec. futures position and sold in the cash market in December • (Like the examples we’ve had before today)

  12. Rolling a hedge: Example • Overall revenue: $0.47 + $2.18 = $2.65/bu

  13. Rolling a hedge: Example • By rolling the hedge forward, made $2.75 - $2.65 = $0.10/bu more than he would have if he just closed out his position in December • Net Price = Original Futures Price – Storage Costs + New Futures Price Difference + New Basis • Risky decision because don’t know realized MAR basis at the time of rolling the hedge • If contemplating rolling hedge in DEC, know all components of equation except B2, need to speculate on this value to decide if better off storing or not • DEC/MAR spread is major factor in decision. If market offers enough premium, can probably risk basis fluctuation and roll the hedge

  14. Rolling a hedge forward: Review • Rolling a hedge forward is exchanging your current position for one in the more distant future • Another way to bet on basis • If basis narrows (or increases ) the short hedge (or example) makes money • Rolling the hedge forward allows you to take advantage of basis changes when you have already taken a position

  15. Calendar Spreads • Can be done with futures or options • Taking long and short positions in the same market for different months • Looking to benefit from price changes between the months • Figuring nearby prices move more quickly than deferred prices

  16. Bull Spread • Buy futures in the nearby month and sell futures in the deferred month • Target when futures prices are rising • Pays off when nearby futures prices rise faster than deferred futures prices

  17. Bull Spread: Example • On March 1, I’m feeling bullish about lean hog futures • July 2019 futures @ $77.975/cwt. • Dec. 2019 futures @ $64.525/cwt. • For a bull spread, I buy 1 July futures and sell 1 Dec. futures on March 1

  18. Bull Spread: Example • On March 29, I want to get out of my bull spread • July 2019 futures @ $92.200/cwt. • Dec. 2019 futures @ $72.975/cwt. • So I sell 1 July futures and buy 1 Dec. futures on March 29

  19. Bull Spread: Example

  20. Bear Spread • Sell futures in the nearby month and buy futures in the deferred month • Target when futures prices are falling • Pays off when nearby futures prices fall faster than deferred futures prices

  21. Bear Spread: Example • On March 1, I’m feeling bearish about corn futures • July 2019 futures @ $3.815/bu • Dec. 2019 futures @ $3.9425/bu • For a bear spread, I sell 1 July futures and buy 1 Dec. futures on March 1

  22. Bear Spread: Example • On March 29, I want to get out of my bear spread • July 2019 futures @ $3.6625/bu • Dec. 2019 futures @ $3.8475/bu • So I buy 1 July futures and sell 1 Dec. futures on March 29

  23. Bear Spread: Example

  24. Class web site: http://www2.econ.iastate.edu/faculty/hart/Classes/econ337/Spring2019/

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