Econ 339X, Spring 2011 ECON 339X: Agricultural Marketing Chad Hart Assistant Professor John Lawrence Professor

Econ 339X, Spring 2011 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

Econ 339X, Spring 2011 CME Group   Products  Agricultural commodities  Corn, soy, cattle, hogs, etc.  Energy  Currency  Metals  Weather  Others

Econ 339X, Spring 2011 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)

Econ 339X, Spring 2011 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

Econ 339X, Spring 2011 Soybean Futures Partial listing of delivery points Source: CME Group Rulebook

Econ 339X, Spring 2011 Delivery Points Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report CornSoybeans Wheat

Econ 339X, Spring 2011 Standardized Contracts  Delivery months  Size of contract  Grains: 5,000 bushels  Corn, wheat, soybeans  Livestock are listed in pounds  Lean Hogs40,000 lbs carcass  Live Cattle40,000 lbs live  Feeder Cattle50,000 lbs live  Specified delivery points  Relatively few

Econ 339X, Spring 2011 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

Econ 339X, Spring 2011 Market Positions  You can either buy or sell initially 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

Econ 339X, Spring 2011 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

Econ 339X, Spring 2011

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

Econ 339X, Spring 2011 Cash vs. Futures Prices Iowa Corn in 2010 The gap between the lines is the basis.

Econ 339X, Spring Basis for Iowa Corn

Econ 339X, Spring 2011 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.

Econ 339X, Spring 2011 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.

Econ 339X, Spring 2011 Going Short Sold Nov $12.73 What type of trader (bull or bear) would go short? What events would send prices in a favorable direction?

Econ 339X, Spring 2011 Going Long Bought Dec $5.48 What type of trader (bull or bear) would go long? What events would send prices in a favorable direction?

Econ 339X, Spring 2011 Class web site: Spring2011/ Have a great weekend!