While we’re on a ‘roll’ with the subject of rolling contracts, 😉 let’s check out what happens if you roll a BASIS contract.
In the case of a basis contract, you have basis set, but not futures. Thus, your cash price is not established.
Understanding what happens when you roll a basis contract can be a bit more confusing than understanding what happens when you roll an HTA (futures only) contract.
With that in mind, don’t get discouraged if you need to work through the following example a couple of times.
Imagine you have the following basis corn contract made with your grain buyer:
Quantity: 10,000 bu
Delivery: 2/1/20 – 2/29/20
Futures = ?
Basis = -0.10 CH20 (March 2020 corn futures)
Cash = ?
Pretend it’s the end of February and your grain buyer is asking you whether you want to price or roll this contract since the March 2020 (CH20) futures contract is about to expire.
They cannot have any outstanding contracts against the March board since it will expire. Thus, all contracts against the March board must be either priced or rolled.
You have some flexibility when it comes to delivering and you think the price might rally in the next couple of months, so you’re considering rolling and delivering in April before planting starts.
Pretend the futures prices for March (CH20) and May (CK20) are as follows:
CH20: $3.80
CK20: $3.85
Before we go any farther, we need to be sure we have an understanding of what the term ‘spread’ means.
The spread is the difference in price between futures months.
By subtracting the more current futures month from the more distant month, you obtain the value of the spread.
In this case, the spread from March ($3.80) to May ($3.85) is $0.05.
$3.85 – $3.80 = $0.05
Now, let’s take a look at the grain buyer’s bidsheet.
Pretend their basis for delivery in February is $-0.15 CH20.
Thus, their cash bid for February is:
$3.80 (CH20) + $-0.15 = $3.65
When the grain buyer rolls their February bid from the March (CH20) to the May (CK20), they will likely change their basis level to ensure they are still bidding for the same cash price.
Just because the May futures month price is $0.05 higher than March doesn’t mean the grain buyer is willing to bid $0.05 higher.
Thus, their cash bid for delivery in February after rolling to May futures (CK20) would be:
$3.85 + $-0.20 = $3.65 (CK20)
The same concept that is used to keep the cash price the same when the grain buyer rolls to the next futures month is also used when rolling your existing basis contract.
In the case of rolling a basis contract, ask yourself the following question to understand what will occur if you roll:
“What would your cash price be today if you set futures on the basis contract?“
$3.80 (current CH20 futures price) + – 0.10 (basis) = $3.70 (cash)
If you were to roll to CK20 and set futures today, what would the basis level have to be to achieve the same cash price?
$3.85 (current CK20 futures price) + (-0.10 + X) = $3.70
X = $-0.05
Basis = -0.15 (basis on original contract – the $0.05 spread between CH20 and CK20)
Thus, the $0.05 spread from CH20 to CK20 makes your basis WIDER.
In either case, whether you choose to roll to the May (CK20) today and price immediately, or if you choose not to roll and instead set futures today off the March, the resulting cash price on your contract would be the same.
Just like the grain buyer adjusts their basis level to account for the spread between futures months to keep their cash bid the same after rolling, the basis level on your contract absorbs the spread as well if you decide to roll.
If you were to roll your March basis contract to May, you would now have the following components established on your contract:
Quantity: 10,000 bu
Delivery: 4/1/20 – 4/30/20
Futures = ?
Basis = -0.15 CK20
Cash = ?
*Be aware that in both roll scenarios, your grain buyer may also charge a FEE to roll.
Taking into account the fee to roll,
the cost of storing your grain longer to deliver later,
and the price risk associated with waiting to set futures and having a wider basis level after rolling,
it’s important to really take time to understand what will occur if you roll before you make the decision to do so.
So, what do you gain by rolling a basis contract?
You gain time to price futures.
That can either be good or bad.
For any of you out there who procrastinate (who, me?!), rolling just puts off making a decision. If that’s the reason you’re rolling, you might want to consider taking a hard look at all your options.
If you really have a bias that the futures market is going up, then rolling can be advantageous since it gives you time to capitalize on a futures move up.
However, it’s dangerous to work off of bias and intuition when you’re talking market prices.
All in all, like any marketing decision, make sure you understand all your options and have a PLAN before you decide to give yourself more time to make a decision.