A client, Bob, call me late last week to say he had 11,700 more bushels of beans than he could store on the farm. Bob and I both expected soybean futures to rally into the end of the year, so he wanted to maintain a long position.
A long position is a financial situation where the investor makes money if the price goes up. One can maintain a long position in beans with beans in the bin, delayed price (price later), basis contract, minimum price contract, call option or buy soybean futures.
We discussed the pros and cons of all of the above tools and Bob decided he wanted to do a basis contract.
Then the question was, “Which month?” I recommended January.
Harvest was going hot and heavy last week in his area, so it was two days before Bob called back. He was somewhat distressed because he had told his merchandiser to put the beans on a January basis contract, but she put them on a March basis.
Bob questioned her briefly and got the usual merchandiser explanation he could not understand, and then Bob told me his merchandiser said she would roll back to January or he could keep the March. Bob told her he would get back to her.
Bob called me and said he had a choice of January or March basis contract. If Bob did a January basis contract with fall delivery, the basis would be 8 under the January futures. If Bob did a fall delivery March basis contract the basis would be 57 under the March.
I immediately knew there was a problem and anybody who truly understands basis would also immediately know there was a problem.
If you grow soybeans and you do not know immediately what the problem is, you've got some homework to do this winter.
The math for basis is the cash price minus futures price. So, based upon what Bob told me, the cash price for fall delivery was 8 under the January futures.
The math: fall delivery cash price minus January futures price = minus 8 cents.
The March basis math was: fall delivery cash price minus March futures price.
If Bob was correct that his January basis contract would be 8 under the January and his March basis contract would be 57 under the March, that would require March beans to be 49 cents higher than January beans.
Why? Because when calculating fall delivery basis for different futures months, the same cash price is used in the formula.
As it turned out, Bob misunderstood what his merchandiser said. She told him the carry from January to March was 8 cents and thus the March basis was 57 under.
Basis contracts are very confusing for most folks, and there is no reason for it. Just remember,
Cash price minus futures price = basis.
The day Bob talked to his merchandiser, the basis was:
- 40 under the November, which = $11.77 cash price
- 49 under the January, which = $11.77 cash price
- And 57 under the March. Which = $11.77 cash price
Make a note of it!
No one associated with Wright on the Market is a cash grain broker nor a futures market broker. All information presented is researched and believed to be true and correct, but nothing is 100% in this business.
The opinions of the author are not necessarily those of Farm Futures or Farm Progress.