Agribusiness Library

1
Agribusiness Library

• Lesson 060097
  Introduction to Commodity Trading

2
Objectives

• 1. Identify and briefly describe the possible
  methods of marketing commodities.
• 2. Describe cash sales, and examine the
  advantages and disadvantages of cash sales.
• 3. Describe forward contracting, and examine
  the advantages and disadvantages of forward
  contracting.
• 4. Investigate the impact of basis on marketing,
  and demonstrate the ability to calculate basis.

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Terms

• basis
• basis contract
• cash sale
• deferred pricing agreement
• forward contract
• futures contract
• option on a futures contract

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What are the methods of marketing commodities?

• The methods of marketing commodities are cash
  sales, forward contracts, futures contracts, and
  options on futures contracts. These methods can
  be used individually or in combination.

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What are the methods of marketing commodities?

• A. A cash sale is a sale that occurs at the
  point of delivery in which the seller receives
  immediate payment for a commodity at the price
  in effect that day.

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What are the methods of marketing commodities?

• B. A forward contract is a
  contract in which a buyer
  and a seller agree to the
  purchase and
  sale of a
  definite quantity and quality
  of commodity at a specific
  price on a
  specific date of
  delivery. This allows the
  price to be set, or locked
  in, thus providing protection from price
  changes.

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What are the methods of marketing commodities?

• C. A futures contract is a contract commonly made
  through a brokerage house that transacts the
  trading for an individual. This contract allows
  the individual to buy or sell a commodity at a
  future date.
• D. An option on a futures contract is the right,
  but not the obligation, to buy or sell a futures
  contract at a specific price before a specific
  time. Options provide price protection and the
  opportunity to benefit from favorable price
  changes.

8
What are cash sales? What are the advantages and
disadvantages?

• The cash sale of a commodity occurs at the point
  of delivery to the cash market, with payment at
  the price in effect that day.
• A. A producer can deliver hogs to a packer or
  grain to an elevator and get cash right away.
  This type of transaction is easy but is one of
  the riskiest marketing choices.

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What are cash sales? What are the advantages and
disadvantages?

• B. A cash market is any physical location where a
  product is bought or sold for cash.
• C. Advantages of cash sales for producers are
• 1. They are easy to transact.
• 2. They provide immediate payment.
• 3. There is no set quantity.
• D. Disadvantages of cash sales for producers are
• 1. They maximize risk.
• 2. There is no price protection.

10
What are cash sales? What are the advantages and
disadvantages?

• E. A deferred pricing agreement is another
  avenue for making a cash sale. The commodity
  is delivered, but the price is set later. This
  allows grain producers to deliver grain, reduce
  the physical risk of holding the grain (corn,
  wheat), and reduce the storage cost without
  having to agree to the current price. A
  producer may deliver wheat to a processor at
  the end of harvest in October and then choose a
  price at a later timefor example, between date
  of delivery and February.

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What is forward contracting?
What are the advantages and
disadvantages of forward contracting?

• In a forward contract, the buyer and the seller
  agree to the purchase and sale of a definite
  quantity and quality of commodity at a specific
  price on a specific date of delivery. This allows
  the price to be set, or locked in, thus providing
  protection from price changes.

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What is forward contracting?
What are the advantages and
disadvantages of forward contracting?

• A. Forward contracting allows a producer and a
  buyer to negotiate price for a later delivery.
  This marketing approach provides price
  protection if an unfavorable price change occurs
  but provides no benefits if a favorable price
  change occurs. The negotiated price still
  applies whether the price goes up or down.
• B. Besides price, the written agreement should
  include quantity, quality, delivery time, and
  location.

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What is forward contracting?
What are the advantages and
disadvantages of forward contracting?

• C. Advantages of forward contracts
  for producers are
• 1. They are usually easy to understand.
• 2. They minimize risk.
• 3. They guarantee the sale of a given quality
  and quantity of a commodity.
• 4. They provide price protection.
• 5. They allow the computation of profit once
  production costs are determined.

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What is forward contracting?
What are the advantages and
disadvantages of forward contracting?

• D. Disadvantages of forward contracts for
  producers are
• 1. They require delivery of a given quality and
  quantity of a commodity.
• 2. There is no benefit from better prices.

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What is forward contracting?
What are the advantages and
disadvantages of forward contracting?

• E. Because a contract is a legally binding
  agreement, it should be developed by a
  lawyer and carefully
  reviewed by both parties
  before signing. A contract should
  include
• 1. The names and addresses of the buyer
  and the seller
• 2. The date of delivery
• 3. The price of the product

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What is forward contracting?
What are the advantages and
disadvantages of forward contracting?

• E. A contract should include (contd)
• 4. The quantity of the product
• 5. The quality of the product and how it will be
  determined
• 6. Exactly how and when payment will be made
• 7. Penalties if either party defaults
• 8. The signatures of both parties

17
What is the impact of basis on
marketing?

• Basis is the relationship between the local cash
  market price and the futures market price.
• A. The cost of delivery of a commodity to a
  specific place is reflected in the futures
  price. The cost of delivery of a commodity to a
  different place is mirrored in the cash price.
  Each of these costs includes transportation,
  storage charges, and marketing costs.
  Therefore, the basis can vary from one market
  or location to another.

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What is the impact of basis on
marketing?

• B. Basis can be seen as consistently positive or
  consistently negative and can change during the
  futures contract length. Knowledge of basis
  patterns and attention to local basis patterns
  is essential in understanding the impact of
  basis on the market.

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What is the impact of basis on
marketing?

• C. The basis is calculated by subtracting the
  price of the nearby futures contract from the
  local cash market price.
• If the cash price for soybeans is 7.50 and the
  futures price is 7.70, the basis is
  7.50 7.70 0.20, or 20
  cents under.
• If the cash price for corn is 4.25 and the
  futures price is 4.22, the basis is
  4.25 4.22 0.03, or
  3 cents over.

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What is the impact of basis on
marketing?

• C. As a basis value approaches positive integers,
  it is said to be strengthening. As a basis
  value becomes less positive, it is said to be
  weakening.

21
Review

• Name the four methods of marketing
  commodities.
• Name the advantages and disadvantages of a
  cash sale.
• What are the important points that should be in
  a forward contract?
• Define basis. How is it calculated?