There are, primarily, three different types of market risk you can face in choosing the wisest marketing tool for the job at hand. They are: futures market risk, basis risk and opportunity risk.
FUTURES MARKET RISK
Whether you have a futures trading account or not, your primary price risk is in the futures market because every other marketing tool available to you is tied either directly or indirectly to changes in futures prices. For that reason, futures risk is the one type of risk that’s generally the same for everybody; it is, in many ways, the common denominator among all buyers and sellers, whether they make their own trades or do so indirectly through other marketing tools available from their grain merchant.
Basis is the difference between the local cash market price and the relevant futures contract. A premium basis is one where the difference is positive, for example, a cash bid in excess of the futures price. A discount basis is a cash bid that’s below the board price. A normal basis is the term given to a multi-year average of local basis for any given time in the marketing year. A basis is said to be unusually strong if the cash bid is at a larger premium or smaller discount to futures than normal for a given time of year in a given region of the country. A basis is said to be weak if at a wider discount or smaller premium than normal for that area.
Local basis varies substantially from region to region across the country and even by time of year in different parts of the country. For example, local basis at facilities dependent on barge freight nearly always deteriorates when the nation’s inland river system freezes and grain transportation becomes limited to the more expensive modes of rail or truck.
The key drivers of basis are typically:
- Distance and transportation cost to the nearest designated warehouse accepting grain for delivery in fulfillment of futures contracts
- The current balance of supply and demand at the local level
- Current “carry” in futures markets (progressively higher bids in deferred contracts to help cover costs of storage)
This is one of the least recognized risks faced by both buyers and sellers, but manageable using certain marketing tools. It’s best explained by noting that a producer faces risk on 100 percent of his/her production throughout the year, regardless of what portion of that production is already priced. Similarly, a buyer faces risk on 100 percent of his/her grain needs throughout the year, regardless of what portion is already covered (purchased).
Because for both buyers and sellers, there is also the risk of lost opportunity, either by pricing too much too soon if a seller or buying too little too late if a buyer.
The shrewd buyer or seller will consider accepting this and look for ways to manage all kinds of risk at any given time.
The views expressed in this article are the author's alone and not those of Farmer's Business Network, Inc., its affiliates or members.