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How Merchandisers Set Cash Price Quotes

The cash price of corn, wheat and soybeans is a function of two other prices, namely futures and basis.

The futures price is a function of world supply & demand whereas basis is a function of local supply and demand.

The futures price is set by traders from all over the world at the various commodity futures exchanges by bid and ask, an auction. For corn, wheat and soybeans, that futures exchange is the Chicago Board of Trade.

Basis is set by the grain merchandisers in each community throughout the world. Basis is the “throttle” by which grain merchandisers controls the flow of grain into their facility.

If soybean futures are at $9.21 and the basis is zero, the cash price is $9.21. If soybean futures are $9.21 and the basis -20, the cash price is $9.01. Likewise, if the basis is +10 with futures at $9.21, the cash price is $9.31.

Mathematically, the formula for determining basis is:

Cash price for a given delivery period minus the futures price for that delivery period = basis.

If the delivery period was April, the basis would be calculated using May futures. If the delivery period was September or October, the basis for corn and wheat would be the plus or minus the December futures price because those two commodities do not have an October or November futures contract. However, there is a November soybean futures contract and the November futures price is used to calculate the cash price for September and October delivery of beans.

If a merchandiser for a feed mill or ethanol plant is paying 12 under the May for (cash) corn, but is not getting quite enough corn the meet his needs, he will “push” (aka firm) the basis by one cent and then his basis would be 11 under the May. If he still needs more corn to come to his facility, he will push the basis another cent or two or three so his basis would be 10 or 9 or 8 cents under the May. Likewise, his cash price would be 10 or 9 or 8 under the May futures.

Meanwhile, another merchandiser buying corn for his feed mill 200 miles away may be paying 5 over the May and not getting enough corn, so he pushes his basis to 6 or 7 or 10 or 15 over the May… he will push (firm) the basis as much as he needs to get enough corn to feed them critters.

Two weeks later, coronavirus could cause a lockdown on the nation and the demand for gasoline is reduced 40 to 50% and, therefore, demand for ethanol is reduced 40 to 50%. Suddenly, the ethanol plant needs half as much corn as it has for the past several years. The merchandiser will weaken his basis by 20 or 30 or 40 cents… However much he has to weaken it to reduce the amount of corn he is buying from farmers.

Back in the days when CBOT traded 9:30 AM to 1:15 PM Central Time and USDA reports were issued at 2 PM, merchandisers would frequently “take protection”, which is the opposite of a basis “push”. A push firms the basis and protection weakens the basis.

Let’s say the market closes on a hot Friday afternoon in July with very little rain expected anywhere in the Corn Belt for ten days. Saturday morning, rain begins to fall in Nebraska and the rain moves through Iowa. By Sunday evening, Iowa has had 1 to 2 inches of rain and Illinois is getting a “million-dollar rain”. Every farmer knows the CBOT will open lower. So does every merchandiser and he knows it will not be possible to hedge new corn sales at a price near Friday’s close. To protect himself, he will weaken his basis before the CBOT opens by the same number of cents he expects the futures market to open lower. That is called “taking protection.”

Now that the futures market opens Sunday night and USDA reports issued during trading hours, there are very few times that it is obvious the market will open significantly lower. Thus, there are very few times there is a need for merchandisers to take protection. But you will see it happen in many times before you die.

Cash Price for Deferred Delivery Periods

Setting the basis for immediate delivery of corn, wheat or beans is very easy for the merchandiser. He has to pay what he has to pay to get enough grain or soybeans in house to meet his needs… A man has got to do what man has got to do!

Setting basis for deferred delivery is tricky for several reasons. The merchandiser does not know how many bushels he will need each of the next thirteen months. He has a good idea if things are normal, but things can sure get abnormal in hurry! Nor does he know the supply.

The merchandiser also knows from records what the basis for his buying station has been for every week since his facility has been in business. He will remember the firmest basis he ever had to pay and the weakest basis he ever paid. The details of those crazy times are so clear in his mind, he could write a short book about what was going on in the community and the world that forced him to those extreme basis levels. It may have been during the blizzard in January of ’78 or the Jimmy Carter Grain Embargo against the Soviet Union in January of 1980 or when the prime rate hit 21.5% in December of 1980 or dot-com bust in March 2000 or the Great Recession in 2008, the Corn Belt drought of 2012 or the Coronavirus Crisis of March 2020.

There is risk in setting the basis for a future delivery period, but that is what a merchandiser gets paid to do. He can hedge the futures price to protect him from futures price change, but there is no way to hedge the basis change risk.

The merchandiser knows, for example, that 9 out of 10 years, the basis for fall delivered corn at his facility ranges between 20 and 30 under the December. The merchandiser also knows that one out of ten years the fall delivery basis has been as firm as +18 and as weak as -43. It is April and farmer wants to forward contract corn for fall delivery. What basis will the merchandiser post for fall delivery? The corn is not even planted yet and the USDA predicts 97 million acres will be planted. With normal yields on that many acres, the supply of corn will overwhelm the storage capabilities of the nation! That means there is a potential for the weakest basis he has ever seen since the 1980 grain embargo. On the other hand, the merchandiser knows market conditions have changed drastically since the USDA collected that acreage information on or about March first. He also knows as bleak as things look now for corn prices, the corn supplies could get quite tight just a few months from now. The merchandiser has to make a decision on his fall delivery basis today! He has a farmer who wants to sell him corn!

He also has to make a decision on the basis for every month’s delivery from now until fall and then each month after fall through at least January and probably March. He records the basis for each month. When a farmer wants to forward contract corn for delivery in July 2020, the merchandiser checks his basis list for July and then looks at September futures and quotes the cash price. The next call he gets may be a farmer wanting to contract corn for January 2021 delivery. Again, he looks at his basis list, the March 2021 futures and gives the quote. Of course, he can change the basis for any or all delivery periods as often he sees fit to get more or less bushels on the books.


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