Find the three ways to “unwind” or settle a corn futures contract when the time comes.
Rodney: So, I'm a farmer. I have say called up my broker maybe and sold futures. So, everybody wants $4 corn. So let's say I sell December 20 $4 futures. Then as a farmer, there's only really one way to exit that contract would be to... Oh, I get the look. You're going to correct me here. As a farmer, I would buy back those futures to exit that contract, where I would get a gain or a loss based on that. As long as I'm hedging, I would offset that with a cash sale that would get me back to the equivalent of that $4 futures. You weren't 100% happy with my answer there. I'm anxious to see where I messed up.
Gabe: I wasn't 100% happy. So that's one path. I initially put on a hedge. I sell December corn futures at a price of $4. And to your point, at some point later, I buy back that position on the Exchange and unwind it. And that will result in a gain or loss, which should be made up for the other side of on a cash sale. So if overall the futures market has gone up, I've got to buy back those futures at a higher price. So I'm paying money into the Exchange, but I should get that back when I make the cash sale.
Gabe: And vice versa. I sell the futures on the Exchange, market goes down. I buy back that position at a lower price. I get some cash. And that offsets a lower sale on the cash side. Since we're talking about it, I'm just going to call out one thing that's really important is I think a place where we've seen people play around is especially that scenario where you've put on a hedge at four bucks. So imagine in today's world, you've got to hedge off at four bucks, or at 3.70 something. And so that hedge is in the money. And so then-
Rodney: So let's clear that up. In the money is what?
Gabe: So it's got equity, so it has value. So I sold it at four bucks, the market's at let's call it 3.70. That hedge is worth 30 cents. And if I'm really hedging, like you said, I'll go unwind that position at the same time, so at a cash price to a buyer, and take that 30 cents that I made and use it to take my cash price back to where it basically has equivalent $4 futures. I have seen so many times, especially when that hedge has value on the Exchange, where people... That's their intent is what we just laid out there. But they go ahead and wait a little bit before they price with the buyer.
Rodney: And when you say a little bit, you're maybe talking days or weeks.
Gabe: Days or weeks. Yeah.
Rodney: Yeah. But there is some risk also in waiting minutes, right?
Rodney: I mean, so it would take an event. But I definitely have been on the transaction side of a guy that had a short futures contract, called up his broker in the morning and said, "Hey, I want to offset that. I'm going to go sell cash. All right. Perfect." And then the markets went against them. So the market went down and it offset that futures contract. And then that afternoon, he called me up and he was like, "Oh God, I forgot to sell my grain. I sold it." And it wasn't major. It was five or 10 cents that he took off that contract, but it really came off his net bottom line. So what guys don't really know, or a lot of guys don't pay attention to, is if you have a brokerage account, most buyers that you work with will do an Exchange with you where you don't have to worry about that anymore. So if I had-
Gabe: So that's called an EFR, EFS. It's an Exchange for risk. And that's exactly right. So you need to know your futures account and your broker, and you need to talk to the buyer ahead of time. You don't want to just assume that they'll do it because for whatever reason, they may not have a process to handle it. But so you have your short position in your futures account, call up that cash grain buyer and say, "Hey, where's basis?" Because now at this point, you're just doing a basis contract. Lock in that basis and say, "Hey, can I just EFR you or EFS you, transfer you my futures position?" And so what will happen is in your account, you'll buy back at the price that you agreed to sell to on the future side with the buyer.
Gabe: And so everybody runs a little bit differently. Generally, the way that works is you're going to buy back the futures at a price close to the current market. And then the buyer will take on the short at that same price. So there's no slippage is what we call that. When there's time between the hedge coming off and pricing the cash, that'd be slippage. So that results in no slippage. And to Rodney's point, a lot of buyers prefer that because they're not specking on futures either. So they're happy to have a nice smooth execution there.
Gabe: So we talked about how you might close a futures contract, really, or unwind it, which does resolve effectively in a settlement. But the other way you can settle that futures contract is just bringing grain to an Exchange certified delivery location. And especially for our farmer listeners, they're on the sell side, they're the ones with the power to decide whether or not they're going to make delivery. So on the Chicago Board of Trade, you can either be long, own a futures contract, or you can be shorter, sold a futures contract. The way the Exchange works on corn is such that the seller of the futures contract decides whether or not to make delivery.
Gabe: So the buyer, so in that delivery window, so for December futures, that's, I don't know, December 1st through the 20th or something. Don't quote me on that. Go to cbot.com if you really want to know the specifics. But as a seller, I would notify the Exchange, "I'm going to deliver 5,000 bushels to fulfill this grain contract." And so then what happens on the other side is the Exchange would go to one of the people that's long a futures contract and tell them, "Hey, by the way, you are taking delivery. I'm giving you notice as the Exchange. You're going to take delivery on 5,000 bushels." And so a farmer can totally deliver on contracts that way. I will also note though, there's generally a lot of fees associated with that.
Rodney: There are a lot of farmers right now thinking back to, what year was it, '08, maybe '09, when wheat basis at harvest was $1.20 under. I was in a few acquisitions there where farmer boards would call me in and say, "Hey, we want to deliver against the Exchange." And that wasn't possible for some reason. Do you remember that? So, I think the nuance there is those guys do have to be able to take delivery, but I think they get to set the fees in which they take that delivery.
Gabe: Yeah. Well, one, I don't know that you get to choose the delivery destination. So the Exchange would probably tell you, "Okay, sure, you're selling, and it's going to be this elevator." And then a big thing of it is, kind of what you're touching on, that elevator, they have some rules around how much grain they have to take every day. And so I think part of what drove in that particular scenario some difficulty around the basis was probably a limit to the amount that people could do. The other thing is you have to do that through the Exchange.
Gabe: I can't call up my elevator and say, "Hey, let's make that contract into the CB..." No, it doesn't work that way. You have to sell futures into the Exchange. And like I said, you have to notify the Exchange. And so you have to call them up and say, "Hey, I'm going to settle this with delivery." And again, we're simplifying for this purpose what that looks like. You need to go read the rules. They are extensive. And there have been various times where I've had to read them over the years, because suddenly I found myself making or taking delivery as a player in the grain market. But it's pretty infrequent, and almost nobody wants to do that.
Rodney: Yeah. And I would say that delivery possibility is what forces the futures market to converge with the cash market. That's why selling corn on the Board of Trade is a really good hedge for the cash market.
Gabe: Yep. Yeah. So that's what keeps it honest. But it's also worth noting it's the cash price at those delivery destinations. So as you get further away for corn from Northern Illinois, that signal is a little bit tougher. It has more noise in it.
Rodney: Well Gabe, that's all the time we got today. Thanks everyone for tuning into the GrainWaves podcast where Gabe and I bring real-time analysis of grain marketing decisions directly to you. If you're new to the podcast, remember to subscribe, leave a five star rating and share with your friends and family. Thanks.
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