1

Basis and Price Formation

2

Basis

Basis is the difference between a cash price at a specific location and the price of a particular futures contract. The cash price offered to a grain producer for any given marketing strategy is a function of local basis.

3

Determination of Basis

Major Factors• COST OF STORAGE: Determines basis

over a given crop year. Also affects the price difference between a nearby and a distant futures contract in a given crop year.

• COST OF TRANSPORTATION: Determines basis geographically.

4

Determination of Basis

Other Factors:

• Local supply and demand conditions

• Grain quality

• Intensity of local competition

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Basis Basis = Cash-Futures Price ( or

Futures - Cash Price) Calculated From Nearby Futures

(Cash - Next Futures Contract to Mature)

Has Predictable Patterns (More Predictable Than Cash Prices)

Not Perfectly Predictable (Basis Risk) Determines the Success of Hedge

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Strengthening and Weakening Basis

Strengthen(less negative or more positive)

Weaken(less positive or more negative)

0

-10

-20

10

20

Cash prices increase relative to futures prices

Cash prices decrease relative to futures prices

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Typical Grain Basis Pattern

Summer SpringFall Harvest

Futures Price

CashPrice

WeakeningBasis

StrengtheningBasis

Harvest BasisLargest

9Predictable Basis Patterns Futures > Cash Prior to Contract

Maturity Futures = Cash Price at Contract

Maturity Basis Widens Into Harvest Basis Narrows During Storage Season Futures and Cash Prices Move Together Basis is Predictable From Year to Year

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Hedging Principle

The Basis Determines the Success of A Hedge

11Basis and Storage Costs

$

Fall Harvest Spring

BasisStorageCosts

Futures Price

CashPrice

P harvest

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Date Cash Market Futures Market

October Harvest Price = $3.00 Sell July Fut. = $3.50

Est. June Basis = $.10Storage Cost = $.30Forward Price = $3.50-.10= $3.40

Storage Profit= $3.40 -3.00 - .30= $.10

June Cash Sale @ $3.30 Buy Back Fut. @ $3.40

Return to Hedge: $3.30 + $.10 = $ 3.40

Corn Storage Hedge

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Corn Basis for North West Wisconsin

-0.60

-0.55

-0.50

-0.45

-0.40

-0.35

-0.30

-0.25

-0.20

Sep Oct Nov Dec Jan Feb Mar Apr May Jun July Aug

1997-98 1998-99 1999-00

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Corn Basis for North West Wisconsin

-0.50

-0.45

-0.40

-0.35

-0.30

-0.25

-0.20

Sep Oct Nov Dec Jan Feb Mar Apr May Jun July Aug

Average

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Soybean Basis for North West Wisconsin

-0.90

-0.80

-0.70

-0.60

-0.50

-0.40

-0.30

-0.20

-0.10

Sep Oct Nov Dec Jan Feb Mar Apr May Jun July Aug

1997-98 1998-99 1999-00

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Soybean Basis for North West Wisconsin

-0.65

-0.60

-0.55

-0.50

-0.45

-0.40

-0.35

-0.30

Sep Oct Nov Dec Jan Feb Mar Apr May Jun July Aug

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Recording Basis

To record historical basis levels, collect closing futures prices for the contract closest to maturity (but not expiring in the current month) each Wednesday, and the corresponding cash price (collected later Wednesday or Thursday morning). Subtract the futures price from the cash price. Average the Wednesday basis calculations for each month to arrive at the average monthly basis level.

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Finding Local Basis Information

•Compile it yourself over several years.

•Contact you local county extension office.

•Contact your local grain brokers, lenders, market advisory services.