In the world of commodity trading, basis plays a crucial role in understanding the relationship between futures and cash prices, said Narciso Perez, director of cattle operations for Zia Agricultural Consultants in Albuquerque, NM.
UNDERSTANDING BASIS
The basis is the numerical difference between the nearest futures delivery month price and the corresponding cash price for a specific commodity, Perez said.
The basis always is calculated by subtracting the futures price from the cash price, he said. A positive basis indicates the cash price exceeds the futures price, while a negative basis shows the futures price is higher than the cash price.
FACTORS INFLUENCING BASIS
Several factors contribute to the basis in commodity trading, Perez said. They include supply and demand dynamics, market participants’ expectations, transportation costs, storage costs and local market conditions.
- Supply and Demand: If the supply of live cattle exceeds demand, the cash price may decrease, leading to a negative basis if the futures price remains relatively stable, he said.
- Market Expectations: The basis also can be influenced by market participants’ expectations regarding future price movements, Perez said. Traders and hedgers analyze various factors like weather conditions, government policies and economic indicators to anticipate price changes. Their expectations affect the basis as they buy or sell futures contracts accordingly.
- Transportation and Storage Costs: Commodities often need to be transported from the location of production to the delivery point specified in the futures contract, he said. Transportation and storage costs can affect the basis, and higher transportation or storage costs in the cash market can lead to a positive basis.
- Local Market Conditions: Basis can also vary based on local market conditions, Perez said. Factors like regional supply and demand imbalances, differences in grading or quality standards, or specific local factors affecting cattle prices can contribute to basis changes.
FUNCTION OF BASIS
The basis serves several important functions in commodity trading.
- Price Discovery: The basis provides market participants with insights into the current supply and demand dynamics in the cash market, he said. It helps traders and hedgers gauge the relative value of the futures contract compared with the underlying commodity. A widening or narrowing basis can indicate changes in market sentiment or fundamental factors affecting prices.
- Arbitrage Opportunities: The basis facilitates arbitrage activities, where traders exploit price discrepancies between the cash and futures markets, Perez said. Traders who feel the basis is too wide or too narrow can try to profit from the perceived imbalance.
- Risk Management: Farmers, processors and livestock producers can use futures contracts to make informed decisions about hedging their price risk by taking opposite positions in the futures and cash markets, he said.
CATTLE, BEEF RECAP
The USDA reported formula and contract base prices for live FOB steers and heifers this week ranged from $186.67 per cwt to $187.23, compared with last week’s range of $177.80 to $188.00 per cwt. FOB dressed steers, and heifers went for $290.41 per cwt to $291.48, compared with $269.90 to $294.94.
The USDA choice cutout Monday was up $4.50 per cwt at $337.43 while select was up $4.53 at $310.24. The choice/select spread narrowed to $27.19 from $27.22 with 63 loads of fabricated product and 17 loads of trimmings and grinds sold into the spot market.
The USDA said basis bids for corn from feeders in the Southern Plains were unchanged at $1.65 to $1.75 a bushel over the Jul corn contract, which settled at $6.17 1/4 a bushel, up $0.13.
No deliveries were tendered against Jun live cattle Monday.
The CME Feeder Cattle Index for the seven days ended Friday was $227.99 per cwt, up $1.87. This compares with Monday’s Aug contract settlement of $239.05 per cwt, up $0.05.