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

Margin Accounts A margin account is an account that traders maintain in the market to ensure contract performance. There are minimum limits on the size of the account. Crop Trader Type Initial Maintenance Corn Hedger/Speculator $1,100 $1,000 Soybeans Hedger/Speculator $2,475 $2,250 Lean Hogs Hedger/Speculator $1,320 $1,200 Live Cattle Hedger/Speculator $1,320 $1,200 To trade, you must create a margin account with at least the “Initial” amount and maintain at least the “Maintenance” amount in the account at the end of each trading day.

Margin Calls Margin accounts are rebalanced each day Depending on the value of futures Settlement price If your futures are losing value, money is taken out of the margin account to cover the loss If the account value falls below the “Maintenance” level, you receive a margin call (a call to put additional money in your margin account) and the balance is brought back up to the Initial amount

Margin Example Let’s say I went short on Mar. 2015 corn $4.02/bushel on Jan. 12 Along with selling a corn futures contract, I have to establish a margin account and deposit $1,100 in it On Jan. 16, the Mar. 2015 corn futures price moved to $3.87/bushel Since I’ll be buying the futures contract later, this price move is in my favor

Margin Example I gained 15 cents per bushel and since the contract is for 5,000 bushels, that’s a gain of $750 At the end of the day (Jan. 17), $750 is deposited into my margin account, raising the account balance to $1,850 Since $1,850 is greater than the “Maintenance” level, I will not receive a margin call

Margin Example #2 Let’s say, instead of going short, I went long on May 2015 corn $4.10/bushel on Jan. 12 Along with buying a corn futures contract, I have to establish a margin account and deposit $1,100 in it On Jan. 16, the May 2015 corn futures price moved to $3.9425/bushel Since I’ll be selling back the futures contract later, this price move is not in my favor

Margin Example #2 I lost 15.75 cents per bushel and since the contract is for 5,000 bushels, that’s a loss of $787.50 At the end of the day (Jan. 16), $787.50 is to be taken from my margin account, lowering the account balance to $312.50 Since $312.50 is less than the “Maintenance” level, I will receive a margin call and be asked to deposit $787.50 more into the account or to close out the futures position The $787.50 brings the account balance back up to the initial requirement

Margin Example – Going Short Date Price Gain Margin Call Account Balance 1/09/15 $4.0025 $1,100 1/12/15 $4.02 -$87.50 $1,012.50 1/13/15 $3.8575 +$812.50 $1,825 1/14/15 $3.81 +$237.50 $2,062.50 1/15/15 $3.80 +$50 $2,112.50 1/16/15 $3.87 -$350 $1,762.50

Margin Example – Going Long Date Price Gain Margin Call Account Balance 1/09/15 $4.0025 $1,100 1/12/15 $4.02 +$87.50 $1,187.50 1/13/15 $3.8575 -$812.50 +$725 1/14/15 $3.81 -$237.50 +$237.50 1/15/15 $3.80 -$50 $1,050 1/16/15 $3.87 +$350 $1,400

Market Participants Hedgers are willing to make or take physical delivery because they are producers or users of the commodity Use futures to protect against a price movement Cash and futures prices are highly correlated Hold counterbalancing positions in the two markets to manage the risk of price movement

Hedgers Farmers, livestock producers Merchandisers, elevators Food processors, feed manufacturers Exporters Importers What happens if the futures market is restricted to only hedgers?

Market Participants Speculators have no use for the physical commodity They buy or sell in an attempt to profit from price movements Add liquidity to the market May be part of the general public, professional traders or investment managers Short-term – “day traders” Long-term – buy or sell and hold

Market Participants Brokers exercise trade for traders and are paid a flat fee called a commission Futures are a “zero sum game” Losers pay winners Brokers always get paid commission

Hedging Holding equal and opposite positions in the cash and futures markets The substitution of a futures contract for a later cash-market transaction Who can hedge? Farmers, merchandisers, elevators, processors, exporter/importers

Cash vs. Futures Prices Iowa Corn in 2014

Class web site: See you at lab, Heady 68! http://www.econ.iastate.edu/~chart/Classes/econ337/Spring2015/ See you at lab, Heady 68!