Commodities: Hedging, Basis and Carry
What the exam tests
This domain tests how commodity derivatives are used to transfer price risk. In the South African market that means the JSE commodity derivatives complex, dominated by agricultural contracts such as white and yellow maize, wheat, sunflower and soybeans, plus precious-metal exposure.
Core rules
- A producer hedges by selling futures; a consumer hedges by buying futures. The futures position is closed out before or at expiry, and the physical trade happens in the cash market.
- Basis is the cash price minus the futures price for the same delivery period. Hedging removes price-level risk but leaves basis risk, which is why the realised hedged price rarely equals the original futures price exactly.
- A market where futures trade above spot, usually because of storage and financing costs, is in contango. A market where futures trade below spot, often from immediate supply shortage, is in backwardation.
- Futures are margined daily: initial margin on opening, variation margin marked to market. Adverse moves trigger margin calls, so a hedger needs liquidity even when the hedge is economically correct.
- Deliverable contracts settle through physical delivery, in the SA grain market typically via silo receipts; other contracts are cash-settled against a reference price.
Worked example: producer short hedge
A maize producer expects 1,000 tonnes and sells futures at R3,500 per tonne. At harvest, spot is R3,200 and the producer buys back the futures at R3,300.
- Cash sale: R3,200 per tonne
- Futures gain: R3,500 - R3,300 = R200 per tonne
- Effective realised price: R3,400 per tonne
- Basis at close-out: R3,200 - R3,300 = -R100
The hedge protected most of the value, but the R100 basis shortfall means the producer realised R3,400 rather than R3,500. Spot fell further than futures, and that gap is the residual risk the hedger carries.
Traps that cost marks
- Reversing contango and backwardation.
- Treating a hedge as eliminating all risk rather than converting price risk into basis risk.
- Ignoring margin calls and assuming the hedge needs no cash while it runs.