One thing you may have noticed about the futures price when we discussed it last week, (find the article here if you missed it!) is that with the futures price, comes a futures MONTH. The futures prices associated with those months are also different prices…but why? To help grasp difficult concepts, I find it helpful to relate it to something in our daily lives.
Today, let’s relate futures months to buying the lumber for a house.
Imagine that you’re building a house in 14 months. You know you’ll need all the wood to frame the house, so you’ve been watching the price of lumber. Right now, the price is fairly attractive and lower than it has been in the last few months. However, you won’t start building for over a year. Since you don’t have a great place to store the wood and worry it would get damaged or warped if you bought it now, you’re not willing to pay the market price today. Even if the price goes up when you’re closer to building, you’re willing to pay a higher price later for reduced risk of damage and storage costs.
Essentially, you’re willing to pay MORE for the lumber THE CLOSER you are to your building date.
Commodity contract futures months work in a similar fashion. Typically, the market price for the commodity will be higher the more distant in the future the contract is. Why? Because the market is essentially ‘paying’ commodity sellers (like you!) to store the grain until there’s a greater need for it in the market. This is similar to what you were willing to do when waiting to make your lumber purchase. There’s some futures market lingo for this situation. When the commodity’s price for futures months farther out are trading a higher than the current trading month’s price, it’s said to be a ‘carry’ market. If the situation is opposite (the commodity is worth more in the current futures month than the more distant months), the market is referred to as being in an ‘inverse’.
Example:
If the May 19 contract for corn is trading at $3.79 and the July 19 contract is trading at $3.89, there’s a $.10 carry in the market.
Now, let’s tackle another question you may have.
What do the letters mean and why are only a handful of the calendar months traded on the futures board?
Let’s look at corn first. The corn contract is traded on the following futures months: March (H), May (K), July (N), September (U) & December (Z). For soybeans, the following futures months may be seen on a grain buyer’s bid sheet: January (F), March (H), May (K), July (N), August (Q), September (U) & November (X). These months are simply listed by the CME–the cash grain buyer does not have any control over these. However, grain buyers across the country are consistent about which futures months they reference for each delivery month. Thus, if you’re looking at cash bids for delivery for corn in June, each buyer will be referencing the July 19 (ZCN19) futures month for their cash bid for June. If you see the corn quote for December of 2019 listed as ZCZ19, don’t be alarmed.
ZC = Standard corn contract
Z = December
19 = Year
Unfortunately, there’s not an easy trick for remembering the abbreviations other than doing some practice looking at price quotes and bid sheets. It really will start to become easier once you look at them consistently! For now, print out the little cheat sheet I have here and keep it next to your computer. [ddownload id=”268″]
Let’s take a look at the bid sheet again to see how the futures reference price works in action. Below are bids for corn, delivery periods are for full month April, May, June, July & October. Notice that both the April & May cash bids reference the May 19 corn futures month.
Note: Keep in mind, futures contracts do expire, or “roll off the board,” at which time they can no longer be traded. For example, the May (K) 2019 corn contract will expire on Tuesday, May 14th of 2019. Prior to the expiration date, the grain buyer will adjust any posted bids referencing the expired futures month to instead reference the new “front” month. For example, in the case of the May (K) contract expiring, the grain buyer will still have a cash bid for May. Thus, prior to expiration the grain buyer will adjust the cash bid for delivery in the month of May to reference the July (N) futures instead.