When it comes to grain trading, basis is a vital concept to grasp. It denotes the difference between a commodity’s local price and its current price on the futures market: Basis = cash market price – futures market price. For grain producers and speculators, basis plays a major role in whether crops are taken to market or stored to sell later.
Being able to recognize discrepancies between the cash and futures markets is a key skill successful grain traders possess. In this article, we’ll break down what basis means to the markets and a few strategies for capitalizing on variance.
Basis 101: Under and Over
At first, the idea of basis can seem a bit abstract. However, much of the mystery falls away by simply looking at a real-world example.
Assume that Carey is a corn grower in eastern Nebraska who is strategizing on how to optimize returns on this year’s crop. Early in the planting season, Carey takes a close look at both corn futures pricing and the local market in Central City, Nebraska. As it applies to grain trading, two forms of basis will play large roles in Carey’s marketing plan: over and under.
On April 15, Carey checks the corn prices at Central City, which come in at $3.85 per bushel. Later in the day, the Chicago Mercantile Exchange’s (CME) May corn futures are listed at $4.05 per bushel. The basis is as follows:
- Cash – futures = basis
- $3.85 – $4.05 = $-0.20
The April 15 basis for corn in eastern Nebraska is -$0.20 per bushel, or “20 under May.” With a negative basis, or cash prices under the futures price, there is ample regional supply. For local producers, this places their crops at a relative disadvantage, and harvest time will be decision time: Do I market or store this year’s crop? For producers with self-storage capacity and a steady cash flow, it may be best to store instead of market.
Now, let’s say that Central City corn prices are significantly stronger, coming in at $4.25 per bushel while May CME corn trades at $4.05 per bushel. The grain trading basis flips:
- $4.25 – $4.05 = $0.20
Now, Carey’s April 15 basis is $0.20 or “20 over May.” A positive basis, or the cash price over futures, suggests that local supplies are short. This places local producers in a strong position relative to the aggregate market. In this case, marketing at harvest time may be the best course of action.
Grain Trading 101: Long and Short the Basis
Given Carey’s potentially long or short basis positions, are there any strategies that can help maximize profits while limiting risk? Yes. By going long or short the basis, Carey can market this year’s crop from a position of strength.
Come September, it’s decision time for Carey. Corn prices in Central City ($3.75) are trading under those of December CME corn ($4.00), producing a “25 under December” scenario. In this case, going long the basis may be a good idea. This grain trading strategy is executed by going long the cash market while shorting the futures market.
To go long the basis, Carey decides to self-store this year’s crop while selling CME December corn. Accordingly, as the basis improves from -$0.25, Carey will realize a profit. If local demand drives Central City prices higher during October, November, or early December, revenues from cash sales will outpace losses taken on the futures short.
In the event that September brings a positive basis, going short the basis may be an ideal strategy for Carey. Assume that Central City corn is going for $4.00 per bushel and December CME corn is trading at $3.75. The scenario is “25 over December,” and the local market is strong. To maximize returns, Carey can market this year’s crop while buying December CME corn; if the futures market rallies to reflect regional pricing, profits will be realized from both the cash sales and long futures position. If not, losses are manageable because robust cash sales outweigh losses taken from the long December CME corn position.
Interested in Learning More About the Ag Markets?
Basis? Over? Under? Without question, the agricultural markets have a language all their own. If you’re interested in learning more about the ag markets, a great place to begin is with a free consultation with an ag expert at Daniels Trading. Whether you’re a producer or a speculator, one of our market pros can help you get the most out of your grain-trading efforts.
