The futures contract is a widely used instrument for hedging the grain and oilseed market. It is used to manage risks for rural producers, agricultural industries and other companies involved in this production chain.

This type of derivative refers to contracts to buy and sell a particular commodity, such as soybeans. Trading is standardized and regulated on the commodities and futures exchange.

If you want to understand how futures contracts work in practice for grains and oilseeds, read on. We explain the details!

What drives an agricultural company and producers to use a futures contract?

The main purpose of futures contracts is to hedge against price volatility in the commodities market, whether for buying or selling. Through it, producers can set the selling price of their crops before the harvest or set the purchase price of inputs, for example.

This also makes for more predictable revenues. After all, the futures contract offers the opportunity to guarantee a fair and competitive price, as it mitigates the financial risks associated with seasonal fluctuations.

Among the main volatility factors are unpredictable weather conditions and fluctuations in supply and demand, both locally and globally. Therefore, by using a futures contract, grain and oilseed market participants can plan their agricultural operations with greater confidence.

Find out more:

• How does volatility impact the commodities market? 

What is basis risk in futures trading?

Before explaining the details of how futures trading works, you must understand basis risk. Almost always, the price of a commodity in a specific city may have different supply and demand fundamentals than the city used as a reference by the futures exchanges.

Example: the price of corn in Sorriso – MT almost always has different fundamentals than corn in Campinas – SP. The latter is the reference city for futures contracts on Brazilian stock B3.

Different supply and demand fundamentals therefore result in different commodity prices between these places. This difference between the price on the stock exchange and the price in a specific place is called the basis. Basis risk is the possibility that the price on the stock exchange will vary more than in the specific location, or vice versa.

For now, for our examples here, we’ll consider that basis risk is non-existent. In other words, the price on the stock exchange is identical to the price traded in a specific market.

Find out more:

• What is basis? We explain the concept to you!

How do grain and oilseed futures contracts for sale work?

Remember when we talked about soybeans at the beginning of the text? Let’s go back to that example. Imagine a producer of this commodity who wants to protect himself from price variations when selling his product. It’s currently May.

First, he needs to analyze the cost of producing his soybeans and the period in which he wants to sell them. Consider that the cost is R$150.00 per 60kg bag and he intends to sell the crop in 90 days, which will be in August.

He decides to look at the prices of soybean futures contracts on reference exchanges such as the Chicago Stock Exchange. He concludes that the quotes are on a positive price curve, with contracts at values that suit his revenues.

Let’s assume that the soybean futures contract, 90 days from now, is being traded according to the following scenarios and values:

In this situation, the selling price in August set by the futures contract will be US$ 35.27 – US$ 30.00 = US$ 5.27/bag as a fixed gross profit. In this case, the producer will be able to hedge his production and obtain more than one possible result. Below, we explain each of the possibilities.

1.    Soybean prices continue to rise

In this case, the soybean price closes at US$16.50/bushel in August, at the time of settlement.

2.    Soybean prices fall

In this case, the soybean price closes at US$15.50/bushel in August, at the time of settlement.

3.    What can we conclude?

In both scenarios, the financial adjustment resulting from the hedge ensures that the final sale price remains stable. In other words, fixed, according to the sale price of the futures contracts in May.

In other words: at the moment of settlement, the producer will sell on the physical market at the price quoted in August. At the same time, he will liquidate his position on the financial market.

He will receive the resulting adjustment, which will be positive if prices fall or negative if they rise. The size of the adjustment will be proportional to the difference between the selling prices of the futures contract and the spot price at settlement. In this way, a fixed final sale price is always guaranteed.

By managing risks with futures contracts, producers don’t have to worry about price volatility until the moment they harvest and sell. They can guarantee the price months in advance. However, the operation will not allow them to increase their profit if prices continue to rise over the period.

Read also:

• Hedge: a guide to understanding this tool and managing risk

And how does the futures contract deal with the purchase of the commodity?

To understand how futures contracts work, think of a consumer in the commodities market, such as a crushing or animal protein industry. When analyzing the world economic situation, it believes that soybean prices are going to rise and wants to hedge against this movement.

In order to hedge against the rise, he buys soybean futures contracts to resell at the time of settlement. He expects a higher price on this date, when he will have to buy the physical product. Imagine that he bought the futures contract at R$40.00/bag.

He will obtain a positive financial adjustment as the price of soybeans rises and remains above the amount paid of US$ 40.00 at the time of settlement. In other words: compensating for the price increase on the physical market. However, if the price falls over time, he will have negative financial adjustments, which will be offset by a lower price on the physical market.

Hedgepoint HUB: knowledge and training for the grain and oilseed market

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