Cash price – forward price = basis (at a certain moment)
A producer’s decision about when and how to market their crops or livestock can have as much of an impact on their net lower profits as any production decision they can make throughout the year. Farmers today have more marketing alternatives than they used to and face a complex and fast marketing system. They must compare traditional marketing methods of selling cash during the harvest (or pre-harvest, on guaranteed secured thunderstorms) or when the stock is ready for the market, in order to pass on contracting or protection with futures or options. To do this, they must thoroughly understand the relationship between different prices in prices, so that they can compare them equally in terms of time, place and quality.
As stated above, the relationship between cash and forward price is known as the “basis”. In marketing, the basis mainly refers to the difference between the price in a certain cash market and a certain price of futures contracts. Basis “localizes” the forward price in terms of location, time, and quality. Understanding the basics makes it possible to compare “quotes with futures price markets” with cash prices and “futures contracts”.
The formula for calculating the base is: Cash price – forward price = base at a given time. A negative basis implies that the price of the futures is higher than the price of cash, and a positive basis implies that the price of the futures is lower than the price of cash.
In this formula, “cash price” refers to a specific location, time, and product quality. The location can be a specific elevator, ethanol factory, packer, etc. Or it can represent the average price for a general area. The weather can represent a specific day or perhaps a weekly average. Quality can be what variety or corn you have or the weight of your livestock. “Futures price” in the formula refers to a contract for the same time that represents the cash price. Product quality at the futures contract price is standardized.
The basis is most often calculated as the difference between the cash price and the near-term futures contract (nearby). 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 a cash price and a more distant futures contract to see if the market is offering a return to storage (“Carry”).
Livestock differs in that you would only consider a nearby basis (not delayed), for hedges and cash sales, because, unlike cereals, livestock is perishable and cannot be stored for long periods of time, as grains can.
In the next section, we’ll discuss ways to “predict the baseline” and ways you can begin to properly track and record baseline data in your area.