Grow Your Finances in the Grain Markets

Temperature, precipitation, and the changing needs of customers all contribute to the supply and demand for commodities like wheat, corn, or soybeans. All of these changes greatly affect the market for agricultural commodities, and grain futures are essential to managing these price swings and providing global benchmark prices. Read on to dig into and learn about the seven major products of the grain markets.

What Are Grain Futures Contracts?

Anyone looking to invest in grain futures should know that the risk of loss is substantial. This type of investment is not suitable for everyone. An investor could lose more than originally invested and, therefore, only risk capital should be used. Risk capital is the amount of money that an individual can afford to invest, which if lost, would not affect the investor's lifestyle.

A grain futures contract is a legally binding agreement for the delivery of grain in the future at an agreed-upon price. The contracts are standardized by a futures exchange as to quantity, quality, time, and place of delivery. Only the price is variable.

There are two main market participants in the futures markets: hedgers and speculators. Hedgers use the futures markets for risk management and withstand some risks associated with the price or availability of the actual underlying commodity. Futures transactions and positions have the express purpose of mitigating those risks. Speculators, on the other hand, generally have no use for the commodities in which they trade; they willingly accept the risk involved in investing in futures in return for the prospect of dramatic gains.

Understanding Futures Contracts

Because they trade at the Chicago Board of Trade (CBOT), futures contracts offer more financial leverage, flexibility, and financial integrity than trading the commodities themselves. Financial leverage is the ability to trade and manage a high market value product with a fraction of the total value. Trading futures contracts is done with a performance margin; therefore, it requires considerably less capital than the physical market. Leverage provides speculators a higher risk or higher return investment.

For example, one futures contract for soybeans represents 5,000 bushels of soybeans. Therefore, the dollar value of this contract is 5,000 times the price per bushel. If the market is trading at $5.70 per bushel, the value of the contract is $28,500 ($5.70 x 5,000 bushels). Based on Apr. 11, 2023 information, the maintenance margin required for one contract of soybeans with a starting and ending period of July 2023 is $3,000. So for $3,000, an investor can potentially leverage $28,500 worth of soybeans.

Advantages and Disadvantages of Grain Contracts

Pros of Grain Contracts

When compared to other types of commodities contracts, such as the various energy products, grains often have a lower margin, making it easy for speculators to participate. Also, grains generally aren't one of the bigger contracts (in terms of total dollar amount), which accounts for the lower margins.

The fundamentals in the grains are fairly straightforward: Like most tangible commodities, supply and demand will determine the price. Weather, transportation, and other conditions will also have an effect. Futures contracts specifically provide a mechanism for buyers and sellers to agree on a price for a specific quantity of grain at a future date which allows market participants to assess the supply and demand for grain and to make informed decisions about planting, harvesting, and storing crops.

One of the most important aspects of grain futures is risk management. Grain futures contracts allow farmers and grain producers to hedge against price fluctuations in the market. By locking in a price for a future delivery, producers can protect themselves against potential losses due to adverse market conditions. This makes it easier for buyers and sellers to compare prices and to enter into transactions.

Last, grain futures are highly liquid. This means there is a large pool of buyers and sellers that transact the product, and transactions can be executed quickly and efficiently. This allows market participants to enter and exit positions easily, which can help to reduce transaction costs.

Cons of Grain Contracts

There are also numerous downsides to grain future contracts. While grain futures contracts can be used to hedge against price fluctuations in the market, there is always the risk that the price of the futures contract will not perfectly match the price of the physical grain being bought or sold. This is known as basis risk, and it can result in losses.

Like any other financial market, grain futures markets may be subject to manipulation by large market participants. This can lead to price distortions and can undermine the integrity of the market especially when larger producers move in tandem.

While most grain futures contracts are settled in cash, some contracts require physical delivery of the grain. This can create logistical challenges for market participants, especially if the delivery location is far from the buyer or seller. In addition, some grain futures contracts only cover a specific subset of the grain market, such as a particular crop or delivery location.

Last, grain futures markets can be subject to significant price volatility. As there are many variables to consider when growing and distributing commodities, the price of any commodity (especially one tied to future projections) are subject to variation. This can make it difficult for market participants to predict future price movements.

Contract Specifications

There are seven different grain products traded at the Chicago Board of Trade: corn, oats, wheat, soybeans, rice, soybean meal, and soybean oil.

Similar grain products trade in other commodities markets around the world, such as Minneapolis, Winnipeg, Bangkok, Brazil, and India to name a few.

Corn

Corn is used not only for human consumption but to feed livestock such as cattle and pigs. Also, higher energy prices have led to using corn for ethanol production.

The CME corn contract is for 5,000 bushels. For example, when corn is trading at $2.50 a bushel, the contract has a value of $12,500 (5,000 bushels x $2.50 = $12,500). A trader that is long $2.50 and sells at $2.60 will make a profit of $500 ($2.60 - $2.50 = 10 cents, 10 cents x 5,000 = $500). Conversely, a trader who is long at $2.50 and sells at $2.40 will lose $500.

In other words, every penny difference equals a move up or down of $50.

The pricing unit of corn is in dollars and cents with the minimum tick size of $0.0025, (one-quarter of a cent), which equals $12.50 per contract. Although the market may not trade in smaller units, it most certainly can trade in full cents during "fast" markets.

The most active months for corn delivery are March, May, July, September, and December.

Position limits are set by the exchange to ensure orderly markets. A position limit is the maximum number of contracts that a single participant can hold. Hedgers and speculators have different limits. Corn has a maximum daily price movement.

Corn traditionally will have more volume than any other grain market.

Oats

Oats are not only used to feed livestock and humans, but they are also used in the production of many industrial products like solvents and plastics.

An oats contract, like corn, wheat, and soybeans, is for the delivery of 5,000 bushels. It moves in the same $50/penny increments as corn. For example, if a trader is long oats at $1.40 and sells at $1.45, they would make 5 cents per bushel, or $250 per contract ($1.45 - $1.40 = 5 cents, 5 cents x 5,000 = $250). Oats also trades in quarter-cent increments.

Oats for delivery are traded in March, May, July, September, and December, like corn. Also like corn, oats futures have position limits. Oats is a difficult market to trade because it has less daily volume than any other market in the grain complex. Also, its daily range is fairly small.

Wheat

Not only is wheat used for animal feed, but also in the production of flour for bread, pasta, and other baked products.

A wheat contract is for the delivery of 5,000 bushels of wheat. Wheat is traded in dollars and cents and has a tick size of a quarter-cent ($0.0025), like many of the other products traded at the CBOT. A one-tick price movement will cause a change of $12.50 in the contract.

The most active months for delivery of wheat, according to volume and open interest, are March, May, July, September, and December. Position limits also apply to wheat.

Wheat is a fairly volatile market with big daily ranges. Because it is so widely used, there can be huge daily swings. In fact, it is not uncommon to have one piece of news move this market limit up or down in a hurry.

Soybeans

Soybeans are the most popular oilseed product with an almost limitless range of uses, ranging from food to industrial products.

The soybean contract, like wheat, oats, and corn, is also traded in the 5,000-bushel contract size. It trades in dollars and cents, like corn and wheat, but is usually the most volatile of all the contracts. The tick size is one-quarter of a cent (or $12.50). The most active months for soybeans are January, March, May, July, August, September, and November.

Beans have the widest range of any of the markets in the grain room. Also, it is generally more expensive per bushel than wheat or corn.

Soybean Oil

Besides being the most widely used edible oil in the United States, soybean oil has uses in the biodiesel industry that are becoming increasingly important.

The bean oil contract is for 60,000 pounds, which is different from the rest of the grain contracts. Bean oil also trades in cents per pound. For example, let's say that bean oil is trading at 25 cents per pound. That gives a total value for the contract of $15,000 (0.25 x 60,000 = $15,000). Suppose that you go long at $0.2500 and sell at $0.2650; this means that you have made $900 ($0.2650 - 25 cents = $0.015 profit, $0.015 x 60,000 = $900). If the market had gone down $0.015 to $0.2350, you would lose $900.

The minimum price fluctuation for bean oil is $0.0001, or one one-hundredth of a cent, which equals $6 per contract.

The most active months for delivery are January, March, May, July, August, September, October, and December. Position limits are enforced for this market as well.

Soymeal

Soymeal is used in a number of products, including baby food, beer, and noodles. It is the dominant protein in animal feed.

The meal contract is for 100 short tons, or 91 metric tons. Soymeal is traded in dollars and cents. For example, the dollar value of one contract of soymeal, when trading at $165 per ton, is $16,500 ($165 x 100 tons = $16,500).

The tick size for soymeal is 10 cents, or $10 per tick. For example, if the current market price is $165.60 and the market moves to $166, that would equal a move of $400 per contract ($166 - $165.60 = 40 cents, 40 cents x 100 = $400).

Soymeal is delivered in January, March, May, July, August, September, October, and December. Soymeal contracts also have position limits.

Rice

Not only is rice used in foods, but also in fuels, fertilizers, packing material, and snacks. More specifically, this contract deals with long-grain rough rice.

The rice contract is 2,000 hundredweight (cwt). Rice is also traded in dollars and cents. For example, if rice is trading at $10/cwt, the total dollar value of the contract would be $20,000 ($10 x 2,000 = $20,000).

The minimum tick size for rice is $0.005 (one-half of a cent) per hundredweight, or $10 per contract. For example, if the market was trading at $10.05/cwt and it moved lower to $9.95/cwt, that would represent a decrease of $200 per contract (10.05 - 9.95 = 10 cents, 10 cents x 2,000 cwt = $200).

Rice is delivered in January, March, May, July, September, and November. Position limits apply in rice as well.

Centralized Marketplace

The primary function of any commodity futures market is to provide a centralized marketplace for those who have an interest in buying or selling physical commodities at some time in the future. There are a lot of hedgers in the grains markets due to the many different producers and consumers of these products. These include, but are not limited to, soybean crushers, food processors, grain and oilseed producers, livestock producers, grain elevators, and merchandisers.

Using Futures and Basis to Hedge

The main premise that hedgers rely upon is that although the movement in cash prices and futures market prices may not be exactly identical, it can be close enough that hedgers can lessen their risk by taking an opposite position in the futures markets. By taking an opposite position, gains in one market can offset losses in another. This way, hedgers are able to set price levels for cash market transactions that will take place several months down the line.

For example, let's consider a soybean farmer. While the soybean crop is in the ground in the spring, the farmer is looking to sell their crop in October after the harvest. In market lingo, the farmer is long a cash market position. The farmer's fear is that prices will go down before they can sell their soybean crop. In order to offset losses from a possible decline in prices, the farmer will sell a corresponding number of bushels in the futures market now and will buy them back later when it is time to sell the crop in the cash market. Any losses resulting from a decline in the cash market price can be partially offset by a gain from the short in the futures market. This is known as a short hedge.

Food processors, grain importers, and other buyers of grain products would initiate a long hedge to protect themselves from rising grain prices. Because they will be buying the product, they are short a cash market position. In other words, they would buy futures contracts to protect themselves from rising cash prices.

Usually, there will be a slight difference between the cash prices and the futures prices. This is due to variables such as freight, handling, storage, transport, and the quality of the product as well as the local supply and demand factors. This price difference between cash and futures prices is known as basis. The main consideration for hedgers concerning basis is whether it will become stronger or weakened. The final outcome of a hedge can depend on the basis. Most hedgers will take historical basis data into consideration as well as current market expectations.

Grain Future Contracts vs. Grain Forward Contracts

Grain futures contracts and grain forward contracts are similar in that they both allow buyers and sellers to agree on a price for a specific quantity of grain at a future date. However, there are several key differences between the two.

First, grain futures contracts are standardized contracts traded on organized exchanges. These futures contracts have a fixed quantity, standard delivery date, and set location. On the other hand, grain forward contracts are typically customized contracts negotiated directly between buyers and sellers. This allows either party to be more flexible with quantity, quality, and delivery terms.

Grain futures contracts are traded on organized exchanges, making them highly liquid. Grain forward contracts, on the other hand, are typically bilateral contracts between two parties. This may make it nearly impossible to liquidate or transfer ownership of a third-party willing agree to all customized terms.

This standardization may not always be bad for a buyer. While futures contracts typically require participants to post margin to cover potential losses, grain forward contracts may not require margin. Instead, the two parties may come up with a specific arrangement of credit.

Last, grain futures contracts typically settle in cash. Physical delivery of grain for a futures contract rarely occurs. Meanwhile, grain forward contracts often involve physical delivery of the grain which can create additional logistical and financial risks. This also creates a very niche type of contract that only those willing to deliver or receive grain should consider.

The Bottom Line

In general, hedging with futures can help the future buyer or seller of a commodity because it can help protect them from adverse price movements. Hedging with futures can help to determine an approximate price range months in advance of the actual physical purchase or sale. This is possible because cash and futures markets tend to move in tandem, and gains in one market tend to offset losses in another.