A 27-Cent Futures Gain That Only Delivered 27 Cents of Protection
You manage origination for a country elevator. On September 10 the elevator owns 60,000 bu of corn that will be sold in November. The local cash bid is $4.10; December futures are $4.35. You short 12 December contracts. On November 12 you sell all 60,000 bu at $3.78 and buy back the December contract at $4.08. Your merchandiser says, 'The cash market dropped 32 cents and we only gave up 5 - that hedge worked.' The board wants to know whether the hedge made or lost money, and whether hedging only the grain already in the bin - rather than expected new-crop receipts - is the right policy. Storage and shrink run about 4 cents per bushel per month.
1. Compute the realized net price per bushel and explain the 5-cent gap between the price you expected to lock in and the price you actually got.
Read the worked answer
Cash leg: 60,000 bu x $3.78 = $226,800.
Futures leg: short $4.35, bought back $4.08 = +$0.27/bu x 60,000 bu = +$16,200.
Net: $243,000 / 60,000 bu = $4.05 per bushel.
Why not $4.10? At inception the basis (cash minus futures) was $4.10 - $4.35 = -25c. At lifting it was $3.78 - $4.08 = -30c. The basis weakened 5c while you were hedged, and 5c x 60,000 bu = $3,000 of value the hedge could not capture.
The shortcut formula is:
Net price = futures price when the hedge was placed + basis when the hedge is lifted $4.35 + (-$0.30) = $4.05
So the hedge did not 'make' or 'lose' money in isolation - it locked the futures price and left you long the basis. Buying the grain and shorting futures is economically the same as owning basis, and your P&L versus plan was a pure basis outcome. (Had you done nothing, the grain would have realized $3.78, so the hedge preserved about 27c per bushel of value.)
2. The board proposes hedging only the 60,000 bu already owned, leaving anticipated new-crop receipts unhedged. What would the average price have been with only 8 contracts, and what are the risks on each side of that choice?
Read the worked answer
With 8 contracts (40,000 bu hedged):
- Futures gain: $0.27 x 40,000 = $10,800
- Cash: $226,800
- Total: $237,600 / 60,000 bu = $3.96 per bushel - 9c worse than the full hedge.
The 20,000 unhedged bushels took the full 32c decline with no offset; $0.32 x 20,000 = $6,400, of which the 9c blended shortfall is the per-bushel expression.
Risk of hedging only owned grain: the elevator is fully exposed on receipts it is effectively committed to buy. Farmers deliver against the elevator's posted bids; if the board is comfortable that basis will strengthen, fine, but nothing in the hedge protects that leg.
Risk of hedging anticipated receipts: an anticipatory hedge leaves the elevator net short if the grain never arrives - drought, a farmer defaulting on a delivery contract, or originations diverted to a competitor. The elevator would then have to buy back futures in a possibly rising market with no cash grain to deliver against, which is a speculative short, not a hedge. The discipline is to hedge anticipated receipts only up to realistically assured volume, and to monitor delivery performance against the hedge.
3. After the November cash sale, the merchandiser suggests leaving the 12 short December contracts on 'in case the market keeps falling.' What has the position become, and what should happen operationally?
Read the worked answer
With the physical grain sold, the short futures are no longer offsetting any inventory or forward purchase - the position is naked short and speculative, whatever the intent.
Consequences:
- Margin: it is margined at speculative rates rather than hedge rates, drawing more of the firm's credit line.
- Limits and reporting: it no longer qualifies for hedge treatment for exchange position-limit and reporting purposes; a position that size may need to be reclassified and counted against speculative limits.
- Risk: the exposure is now to a price rally, with unlimited loss potential and no cash-market offset.
- Governance: the firm's written hedging policy should require that hedge positions be lifted when the hedged exposure is eliminated, and someone independent of the trader should reconcile futures positions against physical inventory and forward commitments daily or weekly.
If the elevator genuinely believes prices will fall, the correct route is a separately authorized speculative account with its own limits and capital - not a hedge that quietly changed character. The recommendation is to buy back the 12 contracts and document that the hedge was closed against the sale.