What is a Basis Contract?
- Futures + Basis = Cash Grain Price
- Basis Contracts are a basic type of grain elevator sale that’s popular with many producers. They allow Farmers to commit bushels to a Buyer by securing a favorable basis price for a specific delivery period. That leaves open the futures portion of the grain contract to be set later when “board” prices (hopefully) improve. *Learn more about the different Types of Basis Markets.
- In short, they’re typically used when a particular grain elevator’s basis looks favorable in the present, but the seller is bullish on futures prices down the line.
- This is the opposite of a Hedge to Arrive or “HTA” where futures are secured first (due to favorable prices) and there’s a belief that basis will improve later on.
Considerations when using Basis Contracts:
- In short, it’s all about weighing how much time you have before delivery and what’s more important in the moment: delivery location flexibility or an attractively high basis price. Ask yourself these 3 questions:
- How many grain elevators do you deliver to? One or many?
- Favorable: If you always deliver one local grain buyer, it’s easier to know how strong their current basis is and commit bushels. Since you’re ultimately going to deliver to them anyway, delivery location flexibility isn’t a relevant factor. That’s why it can be a profitable decision to commit bushels to one elevator by incrementally setting basis as prices look favorable… You can worry about futures prices later if and when they improve!
- Unfavorable: If you deliver to two or more grain buyers and see a stronger than average basis, you should consider how strong that basis is compared to what the other local buyers might do later in the season. Once bushels are committed on a basis contract, they typically must deliver to that elevator. That eliminates flexibility to deliver elsewhere if another location’s basis improves or that facility’s delivery wait times become uneconomical. These scenarios tend to favor delivery flexibility over a moderately strong basis price… Keep your options open!
- What’s the historical strength of basis versus current futures market volatility?
- Favorable: Sometimes we see a basis that’s just too good to pass up. Maybe a facility is desperate for grain and needs to procure it by spiking basis prices. “I’ve never seen the bid that high in my life!” The bid is so high that the chances of any competitor having a higher basis are small. In these cases, it might be a good idea to commit some of your grain to an elevator you’re probably going to deliver grain to anyway.
- Unfavorable: Other times, we see a basis that’s 10 or 15 cents higher than the rest of the local market and get the urge to commit grain there. While that looks like a profitable move, we need to put that market premium in perspective relative to how futures prices move these days. Over the course of the last few crop years, we’ve seen multiple dollar’s worth of futures price action on individual grain contract months. That’s a whole lot more than 10 or 15 cents. Avoid being “penny wise and pound foolish” by being patient with basis and capitalizing on the typically more lucrative futures market by maintaining delivery location flexibility!
- When are you planning to deliver?
- Favorable: The closer we get to a desired delivery period, the less chances there are for basis to change drastically, or for another local Buyer to raise their bid. For example, sometimes we see a strong new crop basis or are planning to clean out the bins with old crop a couple months ahead of Harvest. Short time periods before delivery and an attractively high basis typically outweigh maintaining delivery location flexibility. There’s just not enough time for other local buyers to raise their bids high enough to miss out on guaranteed good prices.
- Unfavorable: The further out we are from the desired delivery period, the more time there is for local conditions to change basis levels. During planting, we may see local Harvest delivery bids 5 or 10 cents higher than normal and be tempted to commit delivery to one location. But we’d be missing the fact that the futures market is more than likely going to move up and down a lot more than 5 or 10 cents over the course of the growing season. Other elevators will probably have new purchasing requirements during that time span where they may have to spike their bid. That means maintaining delivery location flexibility to deliver wherever you want probably will outweigh committing a moderately strong price to one location so early.
- How many grain elevators do you deliver to? One or many?
Summary: When and When NOT to Use Basis Contracts:
- If you deliver to more than one grain elevator, maintaining flexibility in where you’ll be able to deliver (and what basis price you’ll receive) is crucial to a profitable farm operation. It’s one of the few areas of control a Farmer can maintain in grain markets. Setting the futures portion of your cash grain prices separately from a direct sale commitment on basis to an elevator will give you more leverage to be a price maker, rather than a price taker.