BASIS ESTIMATES FOR FEEDER CATTLE AND FED CATTLE
By : Andrew P. Griffith, Assistant Professor, Becky Bowling, UT Extension Specialist
The Key to Successful Forward Pricing
The term basis is used in different ways to define prices in relation to something else. It may be in relation to location or the futures price. In this discussion, basis is defined as the cash price minus the nearby futures price. If the feeder cattle futures price is $130 per hundred and the cash price for feeder cattle is $125 per hundred, the basis is -$5.00 ($125 minus $130 $ = -5.00).
Other uses of the term basis need to be understood to avoid possible confusion. Contract basis is the fixed discount or premium that a buyer is willing to offer in setting the price for cattle to be delivered at a specific time in the future. Another use of the term might be to quote a price such as fed cattle are $130 per hundred basis Dodge City. This simply means the quoted price is for the Dodge City areas. It has nothing to do with forward pricing, futures or options.
Why Basis Is Important
The basis or historical difference in the cash and futures price should be used to adjust or localize the futures price. The historical data is usually available from the Extension Marketing Specialist. The most accurate basis information is that which can be recorded by beef producers when their cattle are sold. Simply note what the cash price is for the cattle and what the futures price is on the same day. If a producer has some record of prices received in the past, the state Extension Marketing Specialist can usually supply the futures prices for those dates.
In hedging with a futures contract, the basis should be used to localize the futures price. This is accomplished by subtracting or adding the basis to or from the futures price. Similarly, the basis is subtracted from or added to the strike price of an option in order to know what floor or minimum selling price is being set by using the option. Once a futures position is taken in the market, the producer should follow the basis as the time of cattle sale approaches. Usually the cash and futures prices come together during the contract month, but it does not always happen. It is to the seller’s advantage for the basis to become less negative or more positive at time of sale. This will allow the net price to be equal to or higher than projected, using the futures and basis estimate before initiating the hedge.
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