Description
This type of contract is the basis of a contract; it permits
the seller to set the futures level on the contract date, but
the basis level is determined by the seller at a later date.
The contract transfers the futures risk and opportunity from
the seller to the buyer on the contract date.
Example: On July 1, a producer agrees to sell
a specified quantity for November delivery. The futures price
is set at $2.50 per bushel per the December contract on the Chicago Board of Trade (CBOT). The
basis level remains open, to be set by the producer at some future
date (usually no later than the date of delivery).
Risk to Seller
The seller's futures risk ends on the date and at the price
of the contract, but the seller retains the basis 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 accepts the futures risk at $2.50 per bushel on
the contract date.
Who Might Use This Contract?
A producer who believes that basis (cash price minus futures
price) will narrow as the referenced contract month approaches.
This producer should be prepared to assume the financial risk
that the basis could widen or invert (cash price above futures
price).
Upside Price Potential. The futures price is established
in the contract, so any gain to the producer will be on basis.
As cash prices and futures prices tend to converge near contract
expiration, basis levels may narrow and some price benefit might
be gained, depending on when the producer establishes the basis
level.
Downside Price Potential. Again, since the futures
price is established in the contract, any gain or loss to the
producer will be on basis. If the basis does not narrow as contract
expiration nears, or if the basis inverts (cash price above futures
price), the producer stands to be liable for such losses.
When Might This Contract Perform Well?
Traditionally, cash and futures prices converge as the
contract expiration date nears. If that relationship holds true,
the producer stands to gain from the narrowed basis level.
When Might This Contract Perform Poorly?
In unusual market conditions, such as occurred in the summer
of 1996 due to low corn stocks and strong demand, the basis (cash
price minus futures price) may not perform as expected. If the
basis widens beyond basis levels on the contract date, producers
will find that their expected sales price will be diminished
by that difference. If extraordinary circumstances result in
an invert (cash prices above futures prices), the producer could
find their sales price considerably reduced from expectations
when they entered into the contract.
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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