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ECON 337: Agricultural Marketing

Learn about agricultural futures markets, futures contracts, and market positions to manage price risks in the agricultural industry. Discover how futures trading works and the differences between cash and futures prices.

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ECON 337: Agricultural Marketing

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

  2. Futures Markets • Organized and centralized market • Today’s price for products to be delivered in the future • A mechanism of trading promises of future commodity deliveries among traders

  3. Futures and Options • Market tools to help manage (share) price risks • Mechanisms to establish commodity trades among participants at a future time • Available from commodity exchanges / futures markets

  4. Agricultural Futures Markets • Has some unique features due to the nature of agricultural businesses • Supply comes online a few times during the year • So at harvest, supply spikes, then diminishes until the next harvest • Production decisions are based price forecasts • Planting decisions can be made a full year (or more) before the crop price is realized • Users provide year-round demand • Livestock feeding, biofuel production, food demand

  5. Futures Market Exchanges • Competitive markets • Open out-cry and electronic trading • Centralized pricing • Buyers and sellers are both in the market • Relevant information is conveyed through the bids and offers for the trades • Bid = the price at which a trader would buy the commodity • Offer = the price at which a trader would sell the commodity

  6. CME Group • http://www.cmegroup.com/ • Products • Agricultural commodities • Corn, soy, cattle, hogs, etc. • Energy • Currency • Metals • Weather • Others

  7. Futures Contracts • A legally binding contract to make or take delivery of the commodity • Trading the promise to do something in the future • You can “offset” your promise • Standardized contract • Form (weight, grade, specifications) • Time (delivery date) • Place (delivery location)

  8. Soybean Futures • Form • 5,000 bushels • No. 2 Yellow Soybeans (at price), No. 1 Yellow soybeans (at 6 cents over price), and No. 3 Yellow Soybeans (at 6 cents under price) • Time • Contract months: Sept, Nov, Jan, Mar, May, July, and August Source: CME Group

  9. Soybean Futures Partial listing of delivery points Source: CME Group Rulebook

  10. Delivery Points Corn Soybeans Wheat Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

  11. Futures Contracts • No physical exchange takes place when the contract is traded (no actual commodity moves) • Payment is based on the price established when the contract was initially traded (prices can and will change before delivery is taken) • Deliveries can be made when the contract expires or the offsetting futures position must be taken to settle up • Deliveries occur on less than 5 percent of the traded contracts

  12. Market Positions • You can either buy or sellinitially to open a position in the futures market • “Make” a promise to make or take delivery • Do the opposite to close the position at a later date • “Offset” the promise (and no commodity changes hands) • Trader may also hold the position until expiration and make or take physical delivery of the commodity

  13. Trading Futures Contracts • All trades through a licensed broker • Brokerage house has a “seat” at the exchange and is allowed to trade • Represented “on the floor” to exercise trade • Local broker to initiate transaction and manage account with client • Full service and discount brokers

  14. CME Group • http://www.cmegroup.com/ • Open, High, Low, Last Price • Settlement Price • Volume • Open Interest • Daily Limits

  15. Terms and Definitions • Basis • The difference between the spot or cash price and the futures price of the same or a related commodity. • Bear • Someone that thinks the price will decline • Bull • Someone that thinks the price will increase

  16. Cash vs. Futures Prices Iowa Corn in 2015 The gap between the lines is the basis.

  17. 2015 Basis for Iowa Corn

  18. Terms and Definitions • Clearing House • The division of the futures exchange through which all trades made must be confirmed, matched and settled each day until offset or delivered. • Commission • For futures contracts, the one-time fee charged by a broker to cover the trades you make to open and close each position.

  19. Terms and Definitions • Long position • A position in which the trader has bought a futures contract that does not offset a previously established short position. • Short position • A position in which the trader has sold a futures contract that does not offset a previously established long position.

  20. Going Short Sold Dec. 2016 Live Cattle @ $124 What type of trader (bull or bear) would go short? What events would send prices in a favorable direction?

  21. Going Long What type of trader (bull or bear) would go long? Bought Dec. 2016 Lean Hogs @ $62 What events would send prices in a favorable direction?

  22. Class web site: http://www2.econ.iastate.edu/~chart/Classes/econ337/Spring2016/ Have a great weekend!

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