On Jan. 4, the Kansas City Board of Trade July wheat contract price of $3.85 matched the contract high that had been set on Oct. 12, 2005. Using a five-year average basis of 34 cents, the market was projecting a June wheat price of $3.51 ($3.85 – 34 cents).
The winter wheat crop is normally made in March, April and May. If moisture is below average during the spring, June wheat prices will average above $3.51. If moisture is above average, wheat prices will be below $3.45.
Since 1986, Oklahoma and Texas Panhandle wheat harvest prices have averaged above $3.50 four times, or 20 percent of the time. The average June wheat price was $3.87 in 1989, $3.88 in 1995, $5.48 in 1996 and $3.47 in 2004.
Ask your local elevator what basis they are offering for harvest delivered wheat. Some elevators in Oklahoma and the Texas are offering a harvest delivery contract with a minus 35-cents basis. Using a minus 35-cents basis, the forward contract price would be 35 cents less than KCBT July wheat contract price.
Currently, the KCBT July wheat contract is about $3.80. Using the minus 35-cents basis, wheat may be forward contracted for harvest delivery for $3.45 per bushel.
A KCBT July $3.80 call option contract may be purchased for about 25 cents. Thus, if wheat is forward contracted for $3.45 and a $3.80 KCBT July “at the money” call is purchased, a minimum price would be set at $3.20.
Forward contracting and buying a call option contract for each 5,000 bushels forward contracted, sets a guaranteed minimum price. The forward contracted price will be received for the wheat and the only cost is the call premium (25 cents).
The net price received will increase by the amount the KCBT July wheat contract price is above the strike price plus the premium ($4.05 in this case). For example, if the KCBT July wheat contract price is $4.20, the net price would be $3.65. This is the $3.45 forward contract minus the 25-cents call premium plus the 40-cents gain for the call.
An expected minimum price may be established by buying a KCBT July put option contract. An “at the money” July put option may be purchased for about 25 cents per bushel or $1,250 per 5,000-bushel contract. Buying a $3.80 July put option for 25 cents produces an expected minimum price of $3.20 ($3.80 - $0.25 – 35-cents basis).
With a put option contract, the price received could be less than the expected $3.20. While the futures price is locked in at $3.80, the basis is not locked in at a minus 35 cents. If prices decline and the basis is lower than the expected minus 35 cents, then the net price received will be less than $3.20.
For example, if in June the KCBT July wheat contract price is $3.40 and the basis is a minus 40 cents, the net price received would be $3.15. This is the $3 cash price received ($3.40 – 40-cents basis = $3) plus the 40-cents put option gain ($3.80 - $3.40) minus the 25-cents premium ($3 + 40 cents – 25 cents).
Forward contracting locks in both the futures price and the basis while buying call option contracts facilitates the capture of a higher futures contract price.
Buying put option contracts lock in the futures price but not the basis while allowing the capture of higher cash prices.
Prices may also be set by selling KCBT July contracts. This locks in the future’s contract price but does not lock in the basis.
The actual June wheat price will be determined by the weather. Much of the winter wheat belt is in drought conditions. Timely rain will result in lower prices than is now being offered and dry spring conditions will result in higher harvest prices.