COMMODITY productSManaging Price Riskwith Grain and OilseedFutures and Options
All producers have market risk –whether they realize it or not is another story.

Like most farmers, grain and oilseed producers tend to focus on production risk rather than market risk. Market risk includes twocomponents: price and basis. Price levels are discovered via the CME Group futures market. Basis is the relationship between a local
cash market price and the CME Group futures price (Cash Price – Futures Price = Basis at a specific point in time). A downturn inprice and/or weakening basis can be just as financially devastating as a poor crop and, in some cases, even more so.
Unlike managing production risk, there are many alternatives available to manage market risk. This paper focuses on two
common producer strategies using CME Group futures and options: short futures hedge and long put option hedge.

Short Futures Hedge
The short futures hedge is the most basic risk management strategy forgrain and oilseed producers. A short position in CME Group futures isinitiated as a temporary substitute for the eventual sale of the commodity
to a local mill, elevator or cash merchant. The short futures position canbe placed well in advance of harvest and will provide price protection until
the cash crop is sold. Immediately upon the sale of the cash crop, the shortfutures position should be closed out (offset). Since prices in the cash
market and futures market generally move up and down together over time,a loss in either of these markets will be offset by a gain in the other – thusAdvantages•••

Eliminates risk of lower price levels
Establishes a selling price level in advance of cash crop saleStrengthening basis improves selling price•Futures position guaranteed by CME Clearing

Disadvantages••

Weakening basis lowers selling priceNo benefit from higher price levels

allowing the producer to lock in a price level in advance of the cash sale.

Evaluation of a Short Futures Hedge

Strategy Notes

Short Futures Price+/- Expected Basis*

As prices moved lower in Scenario 1, the lower cash price was offset by again on the short futures position. Without the short futures hedge, theactual selling price would have been $3.70/bu. As prices moved higher in
Scenario 2, the loss on the short futures position was offset by a higher
cash-selling price. In both scenarios, the actual selling price was the same($5.20/bu) because the basis did not change.       Expected Selling Price*Basis at time of cash market sale

Short Futures Hedge Example: Assumptions
Sell December Corn futures:
Expected basis for November:
Expected selling price:$5.50/bu  -0.30/bu$5.20/buNovember Scenario 1: Falling Prices
Buy (offset) December futures$4.00/buBasis- .30Local cash price

3.70

Futures profit1+1.50

Actual selling price:$5.20/buNovember Scenario 2: Rising Prices
Buy (offset) December futures
Basis
Local cash price
Futures loss2$6.50/bu
- .30
6.20
-1.00

Actual selling price:$5.20/bu

If basis had changed in the scenarios, the results would have been different.
A stronger basis in November (e.g., -.20), would have resulted in a higher
selling price of $5.30/bu, whereas a weaker basis in November (e.g., -.35)
would have resulted in a lower selling price of $5.15/bu.
The short futures hedge locks in a selling price level in advance of thedelivery date. Since basis movement affects the hedge outcome, a goodunderstanding of your local basis and seasonality will be helpful in deciding
if and when to use this strategy. Also, when evaluating futures or options
strategies, you should include the transaction costs.

Sold at $5.50/bu and bought at $4.00/bu
2
Sold at $5.50/bu and bought at $6.50/bu
1

Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money
deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect toprofit on every trade. All references to options refer to options on futures. CME Group is the trademark of CME Group, Inc. The Globe logo, Globex® and CME® are trademarks of Chicago Mercantile Exchange, Inc. CBOT® is the trademark ofthe Board of Trade of the City of Chicago. NYMEX, New York Mercantile Exchange, and ClearPort are trademarks of New York Mercantile Exchange. Inc. COMEX is a trademark of Commodity Exchange, Inc.
The information within this brochure has been compiled by CME Group for general purposes only. Although every attempt has been made to ensure the accuracy of the information within this brochure, CME Group assumes noresponsibility for any errors or omissions. Additionally, all examples in this brochure are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience.
All matters pertaining to rules and specifications herein are made subject to and are superseded by official CME, CBOT and CME Group rules. Current rules should be consulted in all cases concerning contract specifications.
Copyright © 2008 CME Group. All rights reserved.

Long Put Option Hedge
With the advent of commodity options in 1984, a whole new world of risk
management strategies opened for agribusinesses, including the grain
and oilseed producer. The long put option position gives the producer theright (but not the obligation) to sell CME Group futures at a specific pricelevel (strike price). If prices fall below this level, the producer (buyer ofthe put option) has the right to sell the underlying grain or oilseed futuresat the strike price level. Should prices rally above the strike price level,
the producer is not obligated to the put option strike price, and therefore,
can sell their commodity production at the higher market price.
The long put position eliminates downside price level risk whileallowing the producer to sell at a better price level if the markets movehigher. In addition to the price level, the basis level will affect the actual
selling price at the time of the cash sale, just as it did with the shortfutures hedge. A stronger basis at the time of the cash sale improves theselling price while a weaker basis will lower the actual selling price.

Advantages
••
•
•
•

Eliminates risk of lower price level
Establishes a minimum (floor) selling price level
Benefits from a higher price level
Strengthening basis improves selling priceNo margin requirements (put option buyers do not postmargin)• Option position guaranteed by CME Clearing (put optionseller posts margin)

Disadvantages• Weakening basis lowers selling price• Premium is paid in full at time of put option purchase• Transaction costs

Evaluation

Strategy Notes       Put Strike   -   Premium+/- Expected Basis*

As prices declined in Scenario 1, the lower cash market price was offset
by a profit on the long put option position and the minimum (floor)
selling price was achieved. If prices moved even lower, the option
profit would have been greater, providing additional protection against
the lower cash market price. However low the markets declined, theminimum selling price would be achieved. As prices rallied in Scenario 2,
the put option loses value but the cash selling price increases. Although
the cash selling price will continue to improve as price levels increase,the put option loss is limited to the initial premium paid. Therefore, theactual selling price continues to improve as prices move higher. Basiswill have the same impact on the long put option hedge as it did with theshort futures hedge.  Expected Minimum (Floor) Selling Price*Basis at time of cash market saleLong Put Option Hedge Example
Buy 5.50 December Corn put option for $0.35/bu (premium)
Expected basis for early September: -0.30 bu
Expected minimum (floor) selling price: $5.50 - .35 - .30 = $4.85/bu
November Scenario 1: Falling Prices

December futures 		Basis 		Local cash price 		5.50 Dec put option premium		Put option profit3$4.00/bu- .30
3.70
$1.50
+1.15

Actual selling price:$4.85/buNovember Scenario 2: Rising Prices

December futures 		Basis 		Local cash price 		5.50 Dec put option premium
Put option loss4
Actual selling price:$6.50/bu
- .30
6.20
$0.00
- .35         $5.85/bu

The long put option hedge establishes a minimum (floor) selling
price level and retains upside potential. This strategy is very similar toinsurance in that it provides protection for a cost (premium). As withall types of insurance, the insured is protected if the risk occurs (in thiscase, lower prices), but they are actually better off if the risk does notoccur and they don’t have to rely on the coverage (in this case, higherprices).

Summary
The short futures hedge and the long put option hedge are only two of
the many risk management alternatives available by using CME Group
Grain and Oilseed futures and options. The flexibility of futures andoptions allows producers to adjust their market risk exposure to any
level with which they are comfortable.

Buy put at $0.35/bu and sell (offset) put at $1.50/bu
Buy put at $0.35/bu and put expires worthless

34-For more information, contact your broker directly or e-mail commodities@cmegroup.com.
To learn more about CME Group Commodity products, please visit www.cmegroup.com.

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