When the Minneapolis Grain Exchange launched cash-settled crop index contracts, they seemed like a good idea. But almost no one used them.
Instead of burying the moribund contracts, the Minneapolis exchange wants to revive them.
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_____ Updated – Monday November 19, 2007. _____
A story in the Markets section of the November 15, 2007, edition of the Western Producer requires clarification. Read Also
USDA’s August corn yield estimates are bearishThe yield estimates for wheat and soybeans were neutral to bullish, but these were largely a sideshow when compared with corn. The sixth paragraph of the story should have read: Albrecht said many American farmers were uneasy about using longstanding futures contracts for hedging because of deep swings in basis levels between the cash and futures markets and the failure of some major futures contracts to converge with the cash market in the settlement month. And the second-last paragraph of the story should have read: The Minneapolis exchange hopes that now that the problems of traditional futures contracts are apparent, previously reluctant users will be willing to give the cash-settled index contract another try.
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It thinks times have changed.
“The time is right,” said Joe Albrecht of the exchange.
“Their functionality is pretty straightforward and pretty self-evident.”
Albrecht said many American farmers were uneasy about using the contracts for hedging because of deep swings in basis levels between the cash and futures markets and the failure of some major futures contracts to converge with the cash market in the settlement month.
If the cash and futures don’t converge when the farmer delivers his grain, his futures position is more of a speculative gamble than a risk management device.
But the index contracts, which are based on elevator prices across the main grain zones, stay in relative lock step with the cash market. That should make them useful to commercial users of grain and farmers who have been burned by the futures market.
“It’s a new world out there,” said Albrecht. “Historical basis relationships are not what they used to be.”
Volatility in futures contracts, with huge swings in prices occurring many days, shocked many longtime analysts of the derivatives market. While big price swings offer farmers opportunities to lock in higher prices, they also disrupt the tight relationship between cash and futures markets that risk management is based upon.
Cash-settled contracts have some advantages over normal futures contracts, proponents say. They do not expose the holder to the threat of delivery and can be held until they expire.
The difference with this sort of cash-based index is that rather than represent the price of a commodity at a handful of terminal delivery points, it reveals a more widely based cash market value that reflects the world in which the farmer operates.
The idea sounds good on paper, but the Minneapolis exchange has found almost no one to use its index contracts. Recent open interest in the contracts, which include three wheat indexes, a corn index and a soybeans index, ranged from six to 20 open contracts.
Such low liquidity means that most commercial and farmer users would be anxious about using them. Albrecht agreed that there is a chicken and the egg situation in which people won’t use the contracts until they are more heavily traded, but they won’t be more heavily traded until they are more liquid.
However, the exchange is using one market maker now and wants to bring more in to make the index contract more attractive. A market maker is a firm that quotes both a buy and a sell price to ensure a level of liquidity.
The Minneapolis exchange hopes that now that the problems of cash-settled futures contracts are apparent, previously reluctant users will be willing to give the index contract another try.
“There is no shortage of people who would benefit by using these,” said Albrecht.
