Posted by: usset001 | June 8, 2011

Selling futures contracts to price grain

I received an interesting question yesterday. I thought I would share my response.

Question: I am planning on going into farming.  My initial understanding of selling my crop was to take it to the nearest grain elevator and get the day’s spot price, minus the basis and any expenses such as quality and moisture content.

However your articles alluded me to the fact that you can purchase future’s contracts to get a better price for my grain.

My question is: How do I go about actually selling to the futures market? Is there some account with some broker that I have to set up? And after I do sell the my crop on the futures market, how do I get my crop to the buyer?

I am interested in the mechanics. I searched google for hour without any luck. Filling in this gap in my lack of understanding would be greatly appreciated.

Response: You have important questions and I am concerned that a quick response will only inform you enough to be dangerous.

FYI, when you go to your elevator for the spot price, keep in mind that the spot price already includes the basis (spot price = nearby futures + basis).

Yes, an alternative to selling to your local elevator is the sale (not purchase) of futures contracts. Selling futures directly carries several distinct advantages including (1) your average price is usually higher compared to forward contracting because you separate the basis decision and, (2) you are not locked into delivery, so your pre-harvest sale can be rolled into a storage hedge to capture market carry after harvest.

Selling futures only establishes a futures price. When you finally decide to price and deliver your grain (to your local elevator, for example, or another nearby market), then you will call your broker and buy back your futures commitment. You must exit your futures position to avoid delivery issues in the futures market.

Using futures contracts directly also offers a few challenges; (1) you must contract in units of 5,000 bushels, (2) using futures requires a margin account and a broker, and you may need to provide margin additional money as the market fluctuates, (3) you must buy futures to exit the position and, (4) you are exposed to basis risk.

If you would like a fuller explanation on the topic, please read my book, “Grain Marketing is Simple (It’s just not easy)” available at the web site.*/6354018

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