All futures markets are based upon some type of underlying cash or physical market (also called the “prompt” or “spot” market). A futures market must be tied to some type of actual market to keep the futures market price fairly valued and actively traded.
For example, for corn, there is a futures market traded in Chicago and hundreds of “cash” corn markets that set the price that farmers actually receive for the crop they harvest and deliver to their local elevators. Crude oil has a futures market traded in New York and London and a physical crude oil market that prices what is refined into various industrial products such as gasoline. The situation is similar for other raw commodities futures. All have some type of an underlying cash market, even those futures contracts that are settled in cash.
U.S. Treasury bond futures have a cash market, which is the actual debt sold at auction by the U.S. Treasury Department through bonds, notes and bills. Stock index futures also have a cash market, based on the actual prices for individual stocks in the index.
‘Basis’ as a Gauge of Supply/Demand
“Basis” is the difference between the futures price and the cash price – between the price of corn futures in Chicago and the cash corn price at the local elevator, for example. Basis varies, depending on proximity to shipping points, availability of transportation and other factors, not to mention supply and demand considerations and whether users actually want to take delivery of the available supply. Basis can be positive or negative. For example, if supply for a commodity is tight in a given area and demand is strong for the physical commodity, the cash price may be higher than the futures price. Generally, transportation expenses account for the largest portion of cash basis or the difference between cash and futures prices.
Changes in cash basis are not as volatile as changes in cash market or futures prices. Changes in basis tend to follow seasonal patterns. At harvest, grain supplies are generally more plentiful, resulting in a higher demand for transportation services and an increased cost to move grain (wider basis). Post-harvest improvement in basis often occurs because of increased availability of transportation services at a better price and improvements in local supply and demand conditions.
Country grain elevators base the price they will pay farmers for their grain on the price of grain futures at the Chicago Board of Trade. For example, a grain elevator in central Nebraska will likely have a wider basis than will a grain elevator located on the Mississippi River in Dubuque, Iowa, because shipping costs to get grain from the elevator in central Nebraska to the Gulf of Mexico are more than the shipping costs for the elevator located in Dubuque shipping to the Gulf of Mexico.
You might hear a cash soybean price quote from a grain elevator in Nebraska of “28 cents under the May futures contract” whereas the cash soybean quote from a Dubuque elevator might be “8 cents under May futures.” At the Gulf of Mexico, cash soybeans could be quoted at “30 cents over the May contract.” As the cash grain gets closer to its final shipping or other usage destination, basis “narrows.”
Futures traders tuned to fundamentals watch changes in cash basis levels closely because that is one of the best reflections of actual supply and demand. Commercials go to great lengths to keep history and study various cash basis levels for the markets in which they are involved.
Fundamentals Tutorial
For example, for corn, there is a futures market traded in Chicago and hundreds of “cash” corn markets that set the price that farmers actually receive for the crop they harvest and deliver to their local elevators. Crude oil has a futures market traded in New York and London and a physical crude oil market that prices what is refined into various industrial products such as gasoline. The situation is similar for other raw commodities futures. All have some type of an underlying cash market, even those futures contracts that are settled in cash.
U.S. Treasury bond futures have a cash market, which is the actual debt sold at auction by the U.S. Treasury Department through bonds, notes and bills. Stock index futures also have a cash market, based on the actual prices for individual stocks in the index.
‘Basis’ as a Gauge of Supply/Demand
“Basis” is the difference between the futures price and the cash price – between the price of corn futures in Chicago and the cash corn price at the local elevator, for example. Basis varies, depending on proximity to shipping points, availability of transportation and other factors, not to mention supply and demand considerations and whether users actually want to take delivery of the available supply. Basis can be positive or negative. For example, if supply for a commodity is tight in a given area and demand is strong for the physical commodity, the cash price may be higher than the futures price. Generally, transportation expenses account for the largest portion of cash basis or the difference between cash and futures prices.
Changes in cash basis are not as volatile as changes in cash market or futures prices. Changes in basis tend to follow seasonal patterns. At harvest, grain supplies are generally more plentiful, resulting in a higher demand for transportation services and an increased cost to move grain (wider basis). Post-harvest improvement in basis often occurs because of increased availability of transportation services at a better price and improvements in local supply and demand conditions.
Country grain elevators base the price they will pay farmers for their grain on the price of grain futures at the Chicago Board of Trade. For example, a grain elevator in central Nebraska will likely have a wider basis than will a grain elevator located on the Mississippi River in Dubuque, Iowa, because shipping costs to get grain from the elevator in central Nebraska to the Gulf of Mexico are more than the shipping costs for the elevator located in Dubuque shipping to the Gulf of Mexico.
You might hear a cash soybean price quote from a grain elevator in Nebraska of “28 cents under the May futures contract” whereas the cash soybean quote from a Dubuque elevator might be “8 cents under May futures.” At the Gulf of Mexico, cash soybeans could be quoted at “30 cents over the May contract.” As the cash grain gets closer to its final shipping or other usage destination, basis “narrows.”
Futures traders tuned to fundamentals watch changes in cash basis levels closely because that is one of the best reflections of actual supply and demand. Commercials go to great lengths to keep history and study various cash basis levels for the markets in which they are involved.
Fundamentals Tutorial
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