# What is Grain Merchandising, Hedging and Basis Trading?

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5 1a) Long-the-Basis: Under this strategy elevators will initially establish a low buy basis and later sell grain at a higher sell basis. Higher margins will be generated using this strategy as long as the (predictable) change in basis is greater than storage costs in dollar terms. To earn higher margins basis will increase or strengthen from period one (when buy basis is established) to period two (when sell basis is established). For example, a grain elevator buys corn at \$3.50 per bushel during harvest (October) in the cash market from farmers. By simultaneously selling December futures contracts, which are trading at \$3.70 per bushel, a DEC (twenty cents under December) buy basis is formed. If the corn is stored for one month and then sold in November at a cash price of \$3.40 per bushel, the elevator creates a sell basis of DEC (ten cents under December) by buying back the futures contracts at this time for a price of \$3.50 per bushel. The gross profit margin of \$0.10 on the bushels is determined by relative price changes in the cash and futures markets or in merchandising terminology by change in basis. T-Accounts illustrate this example below: Time Cash Grain DEC Futures Basis Buy Sell Buy Sell Oct Buy Basis DEC Nov Sell Basis DEC Gross Margin = 10 cents (Note that the cash position contributes -10 cents and the December futures position +20 cents to Gross Margin, and that the change in basis is equivalent to Gross Margin.) Cost-of-carry (costs associated with storing grain over the period) is calculated: \$3.55 X 10% X = 3 cents Estimated Real # of Cost of Opportunity Interest Days Carry Price

11 eventually price (sell) cash grain to the elevator under the price later contract in July at a price of \$3.10, and the elevator sells September futures at this same point in time at a price of \$3.05, a buy basis will be established. After further adjusting the original sell basis for fees and interest of 16 cents (8 cents per month) to SEP, the elevator s overall margin from the transactions will be 51 cents. T-Accounts illustrate this example below: Time Cash Grain JUL futures SEP futures Basis Buy Sell Buy Sell Buy Sell May Sell Basis JUL June spread ASB SEP Fees and interest of 16 cents ASB SEP July Buy Basis SEP Net Margin = 51 cents (35 cents comes from cash and futures price changes and 16 cents from fees and interest) References: Lorton S., and D. White The Art of Grain Merchandising Silver Edition. Stipes Publishing.

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