Fixed Futures Contract

Knowing he will need to sell it out of the field in the fall of 2000 (also saving him from hauling to on-farm storage, which will require him to handle it a second time), he considers using a fixed futures contract to establish a portion of the next fall's price. Since wheat has a seasonal tendency to rally into the fall, he chooses that time frame to fix a futures contract (sells a futures contract) with his local elevator for his next year's crop. On Sept. 29,1999, the price of the Minneapolis September 2000 futures contract ranged from $3.78 to $3.80, so we will assume the producer sold the futures contract at $3.79, thereby locking in the futures component of the cash price.

By doing so, the producer is committed to deliver 5000 bushels of spring wheat to the grain company with whom which he fixed the futures contract. The producer is, however, leaving the basis component of his cash price open, expecting that it will improve sometime before he has to lock it in. Typically, the producer must complete the cash transaction by locking in the basis component before the 'first notice day' of the fixed futures contract. When he locks in the basis, he has locked in both of the components of the cash price, thereby completing the cash sale. In some cases, the elevator may allow the producer to 'roll' the fixed futures contract to the next futures delivery month, as long as it remains in the same crop year. This would give the producer more time to lock in the basis, but the producer would either have to pay the difference of a futures 'carry', or receive the difference in an inverted market.

For this example, we will use the Portland basis (to arrive at a local basis, subtract your local freight rate from the Portland basis). Throughout the year, basis will vary for different reasons, but by following seasonal basis charts a producer can see that basis tends to have seasonal patterns. Assuming our producer used the seasonal basis chart as a guide, he watched the basis rally into early July, and he then reacted when it began to fall. We will assume that he locked in a $0.78 basis on his fixed futures contract. This would fix a cash price of $4.57 per bushel, not accounting for any quality premiums or discounts. We will assume harvest went as planned and the wheat was delivered by August 25, 2000.

There is some risk involved in using fixed futures contracts. The first is that even if you lose your crop or do not have enough grain to fulfill your obligation, you still owe your local grain company the amount that you contracted to deliver. Most grain companies will let a customer buy back their contract at the current market price if they cannot deliver. If it is lower than where the customer sold than the grain company will likely take a small commission and the producer will make the difference. If the market is higher than where the producer sold the contract at they will have to pay the difference from where they sold and bought the contract back. Since these conditions will vary from company to company, it is important to discuss all available options with individual managers before you enter a contract.