Cash Price – Futures Price = Base (at a specific time)
A producer’s decision as to when and how to market their crops or livestock can have as big an impact on their net profit as any production decision they can make throughout the year. Today farmers have more marketing alternatives than in the past and are faced with a complex and fast marketing system. They should compare traditional marketing methods for making cash sales at harvest (or before harvest, in guaranteed insured caps), or when livestock is ready for the market, to pre-hire or cover with futures or options. To do this, they must have a thorough understanding of the relationship between the different price quotations, in order to be able to compare them equally in terms of time, place and quality.
As stated above, the relationship between cash price and the future is known as the “base”. In marketing, the basis generally refers to the difference between a price in a particular cash market and a specific futures contract price. Basis “locates” the price of futures with respect to location, time, and quality. The basis of understanding allows you to compare “futures market price quotes” with cash and “futures contract” price quotes.
Basics of calculation
The formula for calculating the base is: Cash price – Futures price = Base at a specific time. A negative basis implies that the price of futures is higher than the cash price and a positive basis implies that the price of futures is lower than the cash price.
In this formula, the “cash price” is for a specific location, time, and quality of the product. The location can be a specific elevator, an ethanol plant, a packer, etc., or it can represent an average price for the general area. The time may represent a specific day or possibly a weekly average. Quality can be the grade or corn you have or the weight of your livestock. The “futures price” of the formula corresponds to a contract for the same time that it represents the cash price. The quality of the product in the price of the futures contract is normalized.
The base is most often calculated as the difference between the cash price and the futures contract closest to maturity (close). For example, in June the corn base would be calculated using the current cash price minus the July futures contract price. The grain base can also be calculated using the cash price and a further futures contract to see if the market offers storage returns (“Carry”).
Livestock is different, as only the nearby (non-deferred) base would be considered, for purposes of hedging and selling cash, as, unlike grain, livestock is perishable and cannot be stored for any period. of time, as the great ones can do.
In our next installment, we’ll talk about ways to “predict the base” and how you can start tracking and recording your area’s basic data properly.