This chapter will enable students to understand the different stages of agricultural commodity marketing. At the end of this chapter, students should have an understanding of how agricultural commodity exchanges operate, how the prices of commodities are determined and most importantly be able to argue in favour of /against the presence of hedgers and speculators in the futures market.

1. Agribusiness Marketing
Agricultural Commodity Marketing
Marketing Issues Related To Time
Daisy Odunze

2. Introduction
 The term ‘commodity’ is commonly used in
reference to basic agricultural products that are
either in their original form or have undergone
only primary processing.
 A related characteristic is that the production
methods, postharvest treatments and/or primary
processing to which they have been subjected,
have not imparted any distinguishing
characteristics or attributes.

3. Introduction
 Commodities coming from different suppliers,
and even different countries or continents, are
ready substitutes for one another.
 Agricultural commodities are generic,
undifferentiated products that, since they have no
other distinguishing and marketable
characteristics, compete with one another on the
basis of price.

4. Introduction
Stages Activity Example
Stage 1 Assembly Commodity buyers specialising in specific agricultural
products, such commodities as grain, cattle, beef, oil palm,
poultry and eggs, milk.
Stage 2 Transportation Independent truckers, trucking companies, railroads, airlines
etc.
Stage 3 Storage Grain elevators, public refrigerated warehouse, controlled-
atmosphere warehouses, heated warehouses, freezer
warehouses
Stage 4 Grading and classification Commodity merchants or government grading officials
Stage 5 Processing Food and fibre processing plants such as flour mills, oil
mills, rice mills, cotton mills, wool mills, and fruit and
vegetable canning or freezing plants
Stage 6 Packaging Makers of tin cans, cardboard boxes, film bags, and bottles
for food packaging or fibre products for
Stage 7 Distribution and retailing Independent wholesalers marketing products for various
processing plants to retailers (chain retail stores sometimes

5. Demand as a composite
 Purchases essentially reflect:
 demand for immediate consumption and
 inclination of consumers to restock their shelves or fill
their freezers when prices are particularly attractive or
reduce inventories when prices are high.
 Consumers, consider prices as “attractive” or
“high” based upon anticipated prices.
 Purchases, then, reflect a demand for immediate
consumption and a demand for storage and
speculation.

6. Demand as a composite
 On highly perishable items, demand by
consumers may predominate, but on storable
products and items such as inputs into livestock
feeding, other forces may be very influential.
 Demand to fill storages and provide dependable
flows of feed to livestock facilities may
prominently influence price.
 Food processors have similar demand for
dependable supplies.

7. Demand as a composite
 On such commodities demand for both storage and
speculation may even override the ultimate demand
for consumption in explaining wide swings in farm,
wholesale, and retail prices.
 Demands for storage and speculation strongly reflect
expectations
 Expectations are determined by anticipated utilization
and product availability, and future changes in other
market factors such as agricultural policies. Changing
estimates of next year’s crop may strongly influence
current prices, even though current crop year
availabilities and utilization levels remain constant.

8. Demand as a composite
 Demands for immediate consumption, and storage
and speculation could apply to a domestic market
isolated from the rest of the world.
 Nations participate in an international market and
face an export demand.
 At high prices, the amount demanded of the
domestic product drops sharply at the level of
price that attracts imports (negative exports). At
low levels of price, the domestic product may
become competitive in foreign markets.

9. Demand as a composite
 Therefore, the demand for such a product may be
decomposed into demand for:
 Domestic consumption (by the ultimate consumer).
 Storage (at various levels in the marketing chain).
 Speculation (at various levels in the marketing chain)
 Exports.
 Demand for storage and speculation is more
difficult to identify than demand for consumption
and it is a function of expected gross margins. The
higher the expected gross margin, the more product
will be demanded by storers.

10. Demand as a composite
 If the total amount available is fixed or perfectly
inelastic, the storers bid the product away from
consumers or exporters, which, in turn, tends to drive
up the current price and reduce the expected gross
margin.
 In a competitive market, the new equilibrium price will
depend on how increased amounts in storage affect the
cost of storage per unit of product.

11. Demand as a composite
 If the carryover of the end of the crop year is
anticipated to be unusually low, demands for
storage and speculation may accelerate as the
situation develops. Market prices increase sharply
to ration out limited supplies and protect a
“pipeline carryover”.
 A pipeline carryover can be defined as the amount
needed to assure processors, exporters, livestock
producers, consumers, etc, that their day to day
requirements between crop year will not be
interrupted.

12. Demand as a composite
 In the short run, storage availability may affect
the demand for storage. If excess storage is
available even at the peak of supplies, current
prices will be bid up relative to future prices.
Tight storage situations depress current vis –a –
vis future prices.

13. Demand as a composite
 Forecasting export demand is also challenging in
part due to trade policies in both importing and
exporting nations and foreign food aid programs
of developed nations.
 The prices in importing nations, plus their
population and purchasing power, would establish
the size of the pie.

14. Futures
 Since the early development of agricultural
markets, producers have attempted to protect
themselves against falling commodity prices at
harvest time. Many producers ignored marketing
techniques and sold their commodities at harvest
regardless of the price.
 Today, producers have realised that a marketing
strategy is equal in importance to production,
capital, and labour strategies. The futures contract
as we know it today, evolved as farmers (sellers)
and dealers (buyers) began to commit to future
exchanges of grain for cash.

15. Futures
 What is traded?
 A cash commodity must meet three basic
conditions to be successfully traded in the futures
market:
 It has to be standardized and must be in a basic,
raw, unprocessed state. Perishable commodities
must have an adequate shelf life, because delivery
on a futures contract is deferred.
 The cash commodity’s price must fluctuate enough
to create uncertainty, which means both risk and
potential profit.

16. Futures
 Futures contract is a contractual agreement,
generally made on the trading floor of a futures
exchange, to buy or sell a particular commodity at
a pre-determined price in the future.
 Future contracts are standardized as to quality,
quantity, and time and location of delivery of
delivery for the commodity being traded. The
only variable is price, which is set through an
auction – like process on the trading floor of an
organized exchange.

17. Futures
 A futures contract is an agreement between two
parties: a short position - the party who agrees to
deliver a commodity - and a long position - the
party who agrees to receive a commodity.
 In the above scenario, the farmer would be the
holder of the short position (agreeing to sell)
while the bread maker would be the holder of the
long (agreeing to buy).

18. Futures
 Buyers and sellers in the futures markets look at
current economic information (supply and
demand) and anticipate how it may affect the
price of a commodity.
 The standard features are called contract
specifications. The futures exchange where the
commodity is traded usually provides contract
specifications for commodity. Business journals
are one of the best sources for commodity market
information.

19. Futures
Friday April 16
Corn (CBOT) 5,000 bushels, cents per bushels
Open High Low Settle Change
May 231¼ 231¾ 227 227¾ -4
July 236½ 237¼ 232¼ 233 -4¼
Sept 241¼ 241¾ 237½ 237¾ -3¾
Dec 246 246¾ 242¾ 243½ -3½
A common example of how commodity prices may appear is given below:

20. Futures
 Open is the first price anyone paid for corn on
January 5, 1998.
 High is the highest price anyone paid for corn on
January 5, 1998.
 Settle or settlement is the last price anyone paid
for corn on January 5, 1998.
 Change or net change is the difference between
the settlement price on January 5, 1998, and the
previous trading day.

21. Determining the value of a futures
contract
 Suppose the settlement price for December corn
futures is 200 cents a Kg: that is , $2.00 a kg. To
calculate the dollar value of one corn contract,
multiply the $2.00 settlement price by the contract
size.
 In the case of CBOT corn futures, each contract
equals 5,000 kg of corn, so if 1 bushel of corn is
worth $2.00, then a 5,000 kg contract is worth
$10,000; $ 2.00 per kg times 5,000 kg equals $
10,000.

22. Futures
 Futures contracts do not always trade in even
numbers: sometimes they move in fractions.
 These fractions are the smallest price unit at
which a futures contract trades and are called
minimum price fluctuations.
 In futures lingo it is referred to as ticks.
 The tick size of a futures contract varies
according to the commodity.

23. Futures
 The minimum price fluctuation for a CBOT corn
futures contract, for instance, is ¼ cent per bushel,
or $12.50 per contract (5,000 X $.0025).
 Keeping in mind that the minimum price
fluctuation for CBOT corn futures is 1/4 cents per
bushel, the next few higher prices above corn
trading at 200 cents per bushel ($2.00/bu) would
be 200¼ cents, 200 ½ cents, 200 ¾, and 201
cents.

24. Futures
 When fractions are involved, just use the same
equation of settlement price times contract size.
For example, if December corn futures are trading
at 200 ¼ cents /bu. Then the contract value is
 $2.0025/bushel X 5,000 bushels = $ 10,012.50.

25. Futures
 Determining profit or loss on a futures
contract
 Suppose you read in the paper that soil moisture
in the midlands was below normal for the month
of June and the forecast does not look promising
for rain. Limited rainfall during the growing
season could cause the production of corn to
decrease, thus increasing the price. Anticipating
higher corn prices, you buy one December corn
futures contract at 250 cents/bushels. On July 1, if
you were right and corn prices rise, you will make
a profit.

26. Futures
 Determining profit or loss on a futures contract
 Throughout the month of July, there is no rain in
the Corn Belt. The end result is higher prices, so
you decide to offset your position on July 30 by
selling one December futures contract at
$2.55/bushel.
 Did you make a profit or loss? :

27. Futures
 Calculation: Jul 1 BUY 1 Dec. Corn futures at
$2.50/bushel
 Jul 30 SELL 1 Dec. Corn futures at
$ 2.55/bushel
 Profit $
.05/ bushel
 The total profit is $250 ($.05 X 5000 bushel).
 ** remember that brokerage fees are always
subtracted from your profit.

28. Futures
 Who participates?
 There are two main categories of futures traders
that utilize futures contracts. These are the
hedgers and speculators. Hedgers either now own,
or will at some time own, the commodity they are
trading. Hedger may be producers, elevator
owners, or any others in the agribusiness input
and outputs sectors.

29. Futures
 Speculators are the second major group of futures
players. These participants include independent
floor traders and investors. Independent floor
traders, also called “locals”, trade for their own
accounts. Floor traders handle trades for their
personal clients or brokerage firms.

30. Futures
 Hedging involves taking a position in the futures
market equal but opposite to what one has in the
cash market. If prices fall, a producer who placed
a hedge will be protected. This is why hedgers
willingly give up the opportunity to benefit from
favourable price changes to achieve protection
from unfavourable changes.

31. Futures
 Long (buying) and short (selling) hedgers
 Two terms used to describe buying and selling are
long and short. If you first buy a futures contract,
this is called going long, or going long hedge. If
you first sell a futures contract, this is called
going short, or going short hedge. Hedging in the
futures market is a two step process. Depending
on your cash market situation, you will either buy
or sell futures as your first position.

32. Futures
 if you are going to buy a commodity in the cash
market at a later time, your fist step is to buy a
futures contract. In contrast, if you are going to
sell a cash commodity at a later time, your first
step in the hedging process is to sell futures
contracts.
 The second stage in the process occurs when the
cash market transaction takes place. At this time,
the futures position is no longer needed for price
protection, so it should therefore be offset (closed
out).

33. Futures
 If your hedge was initially long, you would offset
your position by selling the contract back. If your
hedge was initially short, you would buy back the
futures contract. Both the opening and closing
positions must be for the same commodity,
number of contracts, and delivery month.

34. Cash market Futures market
June
Plans to buy 240,000 ibs. Soybean
oil in the cash market at $.26 / ib.
June
Buys 4 CBOT Sept. soybean oil
futures contracts at $.26/ib.
August
Purchases 240,000 ibs. Soybean oil
in the cash market at $.31/ib.
August
Sells 4 CBOT Sept. soybean oil
futures contracts at $ .31/ib.
Purchase price of cash soybean oil $.31/ib
Less futures gain ($.31 - $.26) $.05/ib
Net purchase price $.26/ib
By using CBOT soybean oil futures, the food processor lowered its purchase
price from 31 cents to 26 cents a pound.
That was exactly what the company expected to pay.

35. Cash market Futures market
May
Plans to sell 5,000 bu. Corn in the
cash market at $2.60/bu.
May
Sells one CBOT Dec. Corn futures
contract at $ 2.60/bu.
October
Sells 5,000bu. Corn in the market at $
1.90/bu.
October
Buys one CBOT Dec. Corn futures
contract at $ 1.90/bu.
Sales price of cash corn $ 1.90/bu.
Plus futures gain ($2.60-$1.90) $ 0.70/bu.
Net sales price $ 2.60/bu.
By using CBOT corn futures, the producer increased her final sale price from $1.90
to $ 2.60 a bushel.

36. Futures
 Speculators, in contrast, will likely never own or
even see the physical commodity. They are in the
game to profit from a move up or down in the
market. They have no natural long or short
position as in the case of the hedger.
 Agricultural producers, commodity processors,
exporters, food manufacturers, and others use the
futures market to shift market risk (the risk of
adverse price movements) to someone else.

37. Futures
 The party who assumes the risk is the speculator.
 They just buy and sell futures contracts and hope
to make a profit on their expectations and
predictions of future price movements.
 The profit potential of a speculator is proportional
to the amount of risk that is assumed and the
speculator’s skill in forecasting price movement.

38. Futures
 The profit potential of a speculator is proportional
to the amount of risk that is assumed and the
speculator’s skill in forecasting price movement.
 Speculators always offset their positions by
buying (selling) futures contacts they originally
sold (bought).
 Speculators take a price risk on a given product
with the hope of making a profit.

39. Futures
 The risk a speculator takes is not the same as that
a gambler takes in buying a lottery ticket. In
contrast to gambling, a commodity speculator
assumes a naturally occurring risk rather than one
that is deliberately created

40. Economic functions of futures markets
 Futures exchanges, no matter how they are
organized and run, exist because they provide two
vital economic functions for the marketplace
 Enabling hedgers to transfer price risk to speculators:
 Facilitate price discovery
 Enhancing information collection and dissemination
 Assisting in the coordination of economic activity
 Stabilizing markets and providing liquidity
 Providing flexibility in forward pricing

41. Options on futures
 In contrast to futures, options on futures allow
investors and risk managers to define risk and
limit it to the cost of a premium paid for the right
to buy and sell a futures contract. Options provide
the “opportunity” but not the “obligation” to sell
or buy a commodity at a certain price.

42. Options on futures
 When talking about options, the underlying
commodity is a futures contract and not the
physical commodity. With an option, producers
have the right, but not the obligation to buy or sell
a specific commodity within a specific period of
time at a specific price.
 Futures options are much more attractive to many
hedgers and speculators than straight futures
contracts.

43. Options on futures
 Example of a simplified options contract:
consider a call option that conveys the right to
buy a used combine from your neighbour. You
are debating whether to buy a used combine or to
put up capital for a new combine. You convince
your neighbour to sell you an option to purchase
the combine at any time before April 1. In turn,
the neighbour gives you the right to buy the used
combine for $ 10,000. For this right, you pay
$2,000.

44. Options on futures
 $10,000 is the strike price
 April 1 is the expiration date, and the
 $2,000 you paid for the option is the premium.
 You may choose to not exercise your option-you
can simply let your option expire. You may offset
your current position by selling your option to
someone else. Whatever measure you take, the
writer (seller) of the option keeps the $2,000
premium. With options, once you make a
transaction, you can predict your maximum

45. Options on futures
 A call is an option that gives the option buyer the
right (without obligation) to purchase a futures
contract at a certain price on or before the
expiration date of the option, for a price called the
premium which is determined in open-outcry
trading in pits on the trading floor.

46. Options on futures
 A put is an option that gives the option buyer the
right (without obligation) to sell a futures contract
at a certain price on or before the expiration date
of the option.
 The premium is the cost of futures options. It is
the only variable in the options contract traded on
the trading floor.

47. Options on futures
 Factors affecting premiums
 Intrinsic value: the intrinsic value of an option is
the positive difference between the strike price
and the underlying futures price.
 For a put, the intrinsic value is the amount that the
strike price exceeds the futures price.
 For a call, the intrinsic value is the amount
that the strike price is below the futures price.

48. Options on futures
 For example, when the July corn futures price is
$2.50, a July corn put with a strike price of $2.70
has an intrinsic value of 20 cents a bushel.
 If the futures price increases to $2.60, the option’s
intrinsic value declines to 10 cents a bushel.
 If the strike for a put is below the futures, the
intrinsic value is zero, not negative.

49. Options on futures
 For example, when the December corn futures
price is $2.50, a December corn call with a strike
price of $2.20 has an intrinsic value of 30 cents a
bushel.
 If the futures price increases to $2.60, the options
intrinsic value increases to 40 cents a bushel.
 If the futures price declines to $2.40, the intrinsic
value declines to 20 cents a bushel

50. Options on futures
 Time value: time value originates from the fact
that the longer the time until expiration, the more
the opportunity for buyers and sellers to profit.
 Time value-sometimes called extrinsic value-
reflects the amount of money that buyers are
willing to pay hoping that an option will be worth
exercising at or before expiration.

51. Options on futures
 For example, if July corn futures are at $2.16 and
a July corn call with a strike price of $2 is selling
for 18 cents, then the intrinsic value equals 16
cents (the difference between the strike price and
futures price) and the time value equals 2 cents
(difference between the total premium and the
intrinsic value).

52. Options on futures
 The time value of an option declines as the
expiration date of the option approach. The option
will have no time value at expiration, and any
remaining premium will consist entirely of
intrinsic value. Major factors affecting time value
include the following:
 Time remaining until expiration
 Market volatility
 Interest rate

53. Options on futures
 Ways to exit a futures option position
 Once an option has been traded, there are three
ways you can get out of a position: exercise the
option, offset the option, or let the option expire.
 Exercise
 Offsetting
 Expiration

54.  Reference
 John. N. Ferris (2005) Agricultural Prices
and Commodity Market Analysis 2nd
edition: Michigan state university press.
 James Vercammen (2011) Agricultural
Marketing; Structural Models for Price
Analysis 1st edition, Routledge publishers.