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| In order to hedge effectively, the hedger must have knowledge about expected basis. Traders and brokers have tables that show what a typical basis is in any given month for a particular contract. Sam is a soybean farmer. In October he will harvest 5,000 bushels of soybeans (one contract). Based on past experience he expects the basis on the December contract to be $0.08 in October. That is, a December futures contract will trade in October for $0.08 more than the cash price in October. In January (a slow time for soybean farmers) Sam notes that a December contract is trading at $7.80/bu. Sam figures his cost of production and returns to land is $6.80/bu. So, in January he hedges his crop. Show below how the hedge will work assuming two alternative October cash prices ($6.30 and 9.30) and an October basis of $0.08. |
