This summary is for general illustration purposes only.
Please contact a broker of your choice for information specific
to your operation.
Description
A basis contract is also known as a "Fix Price Later (FPL)" contract. This type of contract transfers the basis risk and opportunity from the seller to the buyer on the date of the contract.
Example: On July 1, a producer sells a specified
quantity for November delivery at .20 Dec. (The November 1 cash price
less 20 cents).
Risk to Seller
The producer has eliminated the "basis" part of
price risk, but has retained the futures risk. The seller also
is subject to production risk; that is, the producer is
responsible for delivering the contracted amount on the delivery
date.
Risk to Buyer
The buyer accepted the basis risk at the time of the contract.
Who Might Use This Contract?
A producer who wants to retain the ability to benefit from
a rising market but who wants to lock in current basis levels
on July 1 might enter a basis contract. The producer should
be financially able to bear the futures price risk of a market
downturn.
Upside Price Potential. The producer retains
the ability to benefit from higher prices at delivery in November,
while transferring the risk that basis levels might widen to
the buyer.
Downside Price Potential. The producer faces
the risk that market prices might fall by November 1. However,
the producer still has transferred basis risk to the buyer.
When Might This Contract Perform
Well?
This contract will work to the producer's advantage to increase
income if market prices rise between July 1 and delivery in November.
When Might This Contract Perform
Poorly?
This contract will not perform as well for the producer if
prices fall between July 1 and November delivery. The producer
bears the risk of market prices falling, but his or her basis
risk is covered.
Mention of product names or firms does not
necessarily constitute endorsement by the Risk Management Agency
or the U.S. Department of Agriculture over others not
mentioned, and is for information purposes only.
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