Understanding and Using the Basis

by
John C. McKissick and George A. Shumaker
Extension Agricultural Economists-Marketing

Understanding the concept of basis is a key element in developing a sound marketing

plan. Basis refers to the relationship between the cash price in a local market and the futures
market price for a commodity. A more formal definition of basis is the difference between
the cash price and the futures price, for the time, place and quality where delivery actually
occurs. Even if a farmer never uses the commodity futures market directly, knowledge of the
basis can be of great value in making more profitable decisions on other commodity marketing
alternatives.
The commodity futures market price quotations reflect the collective opinion of
thousands of traders concerning the overall supply and demand balance for a commodity. In
today's world, the futures markets reflect a market of global proportions. Commodity prices in
Georgia are directly influenced by the worldwide supply and demand factors made apparent in
the futures markets.
While Georgia prices are heavily influenced by the futures market, they are seldom
identical to the futures market prices in Chicago or New York City. Georgia prices rise when the
futures market prices rise and fall when the futures prices fall but there is usually a difference in
actual prices between the two market areas. The difference between Georgia cash prices and the
futures market prices is called the basis. This basis reflects the supply and demand situation in
the local Georgia market area and changes as local conditions change. Georgia buyers signal
their eagerness or reluctance to purchase by changing the basis.

ESTIMATING THE BASIS

Basis is defined as the cash price minus the futures price and is calculated by subtracting
the appropriate futures market quote from the spot price (current cash market price). If the spot
price for corn is $2.85 per bushel and the nearby futures contract is $2.75, then the basis is $2.85-
$2.75 = +$.10.
Generally, reasonably accurate basis estimates can be obtained by selecting a day during
the week to collect a cash and futures price quote and averaging this value over a three- to five-
year period. In the grain trade, buyers typically post cash bids at the close of futures market
trading each day, and these bids usually remain in effect until the following futures close. Friday
morning's cash prices and Thursday's closing futures prices are often used to calculate the basis.
Cash grain and cotton prices can be obtained from most buyers over the telephone.
Cash livestock prices are available from State and Federal market news services or farm
organizations. Commercial vendors also provide price quotes for a fee. Historic futures prices
can be found in newspaper files. Current futures quotes can be obtained from most newspapers,
radio stations and private vendors. Appendix A provides a handy table for collecting weekly
basis observations.

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 Basis estimates are also prepared and periodically updated by the Department of
Agricultural Economics of the Georgia Cooperative Extension Service. This department also has
a computer program available that calculates the basis. The most recent basis estimates for
Georgia are available through your county Extension office.

INTERPRETING THE BASIS

Whenever the basis is not zero, the local supply and demand factors are different from
those prevailing in the futures market. The basis can be positive or negative and is preceded by a
plus or minus sign. A basis preceded by a negative sign indicates the local spot price is less than
the futures market and implies the local supply is greater than local demand. When the basis
formula generates a positive sign (the cash price is greater than the futures market), it means the
cash market is trading at a premium to the futures. A basis with a plus sign indicates that the
local demand is greater than the local supply. The basis must include the correct mathematical
sign for correct interpretation by farmers and handlers.
Basis seldom remains constant because local supply and demand conditions continually
change through time. Changes in the basis are known as basis patterns. In order to use basis to
select among marketing alternatives, basis theory and associated concepts must be understood,
and basis patterns are one of the important concepts. An "improving" basis changes from "weak"
(the cash price is low relative to the futures price, indicated by a wide difference as in Figure 1)
to "strong" (the cash price is high relative to the futures price, indicated by a narrow difference as
in Figure 1). In Figure 1, a normal soybean basis is weak during November, at -$.30. By August,
the basis is strong, at -$.10. The basis for crops is usually weakest during the harvest period and
strengthens during the marketing year as in Figure 1. In Figure 2, corn basis is weak in
September, at +$.05, and strong in May, at +$.40. In Figure 3, the cotton basis weakens over
time.
A "weakening" basis changes from strong to weak. A "strengthening" or improving basis
change from weak to strong. The terms "strong" and "weak" are relative terms. Consider the
present basis to be strong when it is greater than the historic average basis for that point in time.
For example, if the present hog basis is +$2.00 per cwt. and the average for the last three years
was +$.50, the current basis is strong.

Figure 1.
Improving basis

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Figure 2.
Improving
inverted basis

PREDICTABILITY OF THE BASIS

Although the basis varies throughout the year and from one year to the next, it tends to be
more predictable and less extreme than changes in the price of the commodity. Table 1 contains
the spot price and basis for beans in Bulloch County for various points in time. It illustrates that
basis more stable than spot or futures prices. Over the period covered, the ran of cash soybean
prices was $4.86 from a low of $4.80 to a high of $9.76. Bas ranged $.55 from a strong point of
+$.Ol to the weak point of -$.54. Other crops and livestock examples would show similar results.
The basis is mo stable and more predictable than the cash price.

GRAIN, COTTON AND LIVESTOCK BASIS USE

Basis use differs between livestock (non-storable commodity) and grain and cotton
(storable commodity) markets. The remainder of this publication will discuss the important
aspects of basis for both commodity groups.

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Table 1. Bulloch County cash soybean prices and basis for selected dates, 1983 - 1991

Date $ Cash Price $ Change in Basis in $ $ Change in

Cash Price Basis
6/16/83 5.60 --------- -.30 --------
8/25/83 9.05 +3.45 -.20 +.10
12/22/83 7.50 -1.55 -.05 +.15
2/9/84 7.08 -.42 +.01 +0.6
5/24/84 8.58 +1.77 .00 -.01
12/20/84 5.81 -3.04 -0.6 -0.6
6/13/85 5.85 +.04 -.05 +.01
10/20/85 4.80 -1.058 -.22 -.17
11/10/86 4.88 +.08 -.12 +.10
5/28/87 5.35 +47 -.17 -.05
6/30/88 9.76 +.41 -.54 -.37
7/1/90 6.04 -3.72 -.24 +.30
6/6/91 5.60 -.44 -.21 +.03

GRAIN AND COTTON BASIS USAGE

In the grain and cotton industries, prices for current cash (the spot market) and future
delivery (bookings) transactions are commonly quoted in terms of the basis. For example, an
export terminal might bid "10 cents under the November" for new crop soybeans from a local
elevator, which means that the buyer's cash bid is 10 cents below the current futures quotation for
the November futures contract. The primary concern of most commodity merchandisers is the
price differential between two points and not the absolute level of prices. Once a commodity
leaves the farm it is typically priced using the basis rather than a flat cash quote.
The concept of basis is used in other ways. The basis commonly refers to the difference
between the local cash price and the nearby futures contract or the contract closest to expiration.
For future delivery transactions, the basis will be quoted from a contract with a longer maturity
time. Cash forward contracts or bookings for delivery at harvest are typically priced "basis the
harvest contract" for the commodity in question. The futures market harvest contract for Georgia
corn is usually the September contract, for soybeans it is the November contract, for cotton it is
the December contract and for wheat it is the July contract. These contracts expire closest to but

4
not before the normal harvest period and reflect the expected price conditions for that crop.

READING GRAIN AND COTTON BASIS TABLES AND CHARTS

Tracking the basis over time provides a reference from which basis patterns can be identified.
Two formats provide different methods for observing basis patterns. The traditional format for
presenting basis estimates is a basis table (Table 2). Another method is to graph the data to
provide a picture so the basis pattern is easier to identify (Figure 4).

Figure 4.
Graphical
presentation
of historical
basis pattern

A basis table is construct

ed with the futures contract
delivery months listed across the top of the table. The months when cash sales can be made are
listed in the left hand column. The figures in the body of the table are the basis estimates. Three
numbers are provided for each calendar month of the marketing year for each remaining futures
contract. The top number is the expected basis value or the average basis value for that month
over a three-year period. The second number is the optimistic value or the strongest value
observed for the month. The bottom number is the pessimistic value or the weakest basis
observed. These three values provide the best point estimate, the expected value and a range in
which future values likely will occur.

Table 2. Basis table for soybeans in Bulloch County, 1987 - 1989, in dollars

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Cash Sale
Month NOV. JAN. MAR. MAY JULY AUG. SEPT.
Oct. E -.23 -.34 -.44 -.49 -.51 -.45 -.19
O -.20 -.27 -.35 -.39 -.37 -.26 +.37
P -.40 -.50 -.56 -.57 -.63 -.63 -.45
Nov. E -.14 -.25 -.34 -.40 -.43 -.39 -.21
O -.09 -.16 -.22 -.26 -.27 -.24 +.14
P -.20 -.30 -.43 -.53 -.60 -.60 -.52
Dec. E -.21 -.33 -.41 -.45 .40 -.16
O -.15 -.23 -.28 -.32 -.27 +.21
P -.30 -.42 -.48 -.54 -.55 -.53
Jan. E -.15 -.36 -.44 -.44 -.43 -.31
O -.06 -.15 -.28 -.34 -.33 +.02
P -.31 -.42 -.56 -.58 -.50 -.52
Feb. E -.22 -.33 -.41 -.41 -.34
O -.15 -.27 -.35 -.36 -.16
P -.30 -.45 -.53 -.48 -.47
March E -.17 -.25 -.35 -.36 -.28
O -.05 -.04 -.18 -.21 -.06
P -.31 -.45 -.53 -.49 -.40
April E -.19 -.30 -.33 -.30
O -.15 -.25 -.27 -.14
P -.26 -.28 -.29 -.24
May E -.26 -.28 -.29 -.24
O -.16 -.25 -.11 +.16
P -.41 -.31 -.37 -.40
June E -.39 -.39 -.26
O -.05 -.05 +.35
P -.26 -.26 -.87
Aug. E -.13 -.08
O +.12 +.25
P -.32 -.30
Sept. E -.12
O -.08
P -.19

E = Ex
O = Optimistic
P = Pessimistic

A three-year period is a well-used standard for grain basis calculations any economists. Basis
patterns do change over time due to changes in production and market competition within an

6
area. The averages of a longer time period would dilute the changes. A shorter time period may
not contain enough information to indicate changes in pattern or normal year-to-year variation.
Figure 5 shows the changes in basis patterns for corn over a three-year period.

Figure 5. Changes
in Bulloch County
corn basis patterns,
1987-1989

GRAIN AND COTTON BASIS PATTERNS

Factors that affect the grain and cotton basis are the supply of and demand for storage,
farmers' willingness to sell, buyer competition and transportation considerations. Cash price
discounts for- sub-par quality delivered weakens the basis for the individual seller. Basis patterns
vary as adjustments are made to the local supply and demand situation. The basis for crops is
generally weaker in large crop years than in small crop years. The wheat and soybean basis in
southeast Georgia is often strengthened sharply by the nature of operations of the export terminal in
Savannah. The storage capacity of the terminal is less than the capacity of many of the ships that
load there. To avoid ship delay (demurrage) charges, the grain merchant strengthens the basis to
attract enough grain to load out the ship within the allotted time. Similarly, the temporary shutdown
of a soybean crusher weakens the soybean basis within its market area.
Due to transportation costs, it is not surprising that basis differs between interior county
elevators and export facilities. Basis is usually weaker with increased distance from the destination
of a commodity. The impact of transportation costs on basis is true for grains and cotton. Georgia
cotton prices tend to be higher (stronger basis) than the prices for similar cotton produced on the high
plains of Texas. Transportation costs between production areas and usage areas are a primary
determinant of the basis.
Most basis patterns for Georgia crops are reasonably predictable because of the carrying
charge, local storage considerations (both capacity and ability) and transportation costs. The carrying
charge exists because stored commodities are harvested and stored once a year, while consumption
occurs continuously throughout the year. There are financing, storage and management costs
associated with the storage activity. Assuming rational behavior, the futures markets tend to reflect
both past and future carrying charges, while the cash price reflects only past carrying charges.

7
Therefore, it is probable that cash prices should rise in relation to futures prices and the basis should
strengthen throughout the storage season (Figures 6, 7 and 8).

Figure 6. Typical
Georgia soybean
basis pattern

Figure 7.
Typical Georgia corn
basis pattern

Figure 8.
Typical Georgia

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 wheat basis pattern

The storage capacity i n

Georgia has not been sufficient to handle the entire crop of soybean and corn at harvest.
Consequently, farmers are forced to sell a portion of the crop from the field. This pressures the local
cash price relative to the futures and the basis weakens at harvest. The basis strengthens after the
harvest glut is handled by the marketing system.
In the case of wheat, another storage factor affects the basis (Figure 8). It is difficult to store
wheat in Georgia, due to climatic and insect pressures. Also, the capacity of most of the grain
elevators limits the handling of one or at the most two commodities at one time. The wheat basis
patterns weaken during the harvest glut, and strengthen after wheat harvest until the corn and
soybean harvests near. At that point, the elevators prepare for the coming corn and. soybean crops
and the wheat basis weakens again. Basis often strengthens after the harvest glut of the other crops
has passed. In many cases local bids for cash wheat cease when the corn harvest begins.
There is another overriding factor that influences corn and soybean meal basis patterns in
Georgia. Georgia is a deficit area in the production of these commodities relative to consumption.
Livestock and poultry producers must rely on Midwest-produced corn and soybean meal for their
feeding needs during portions of the year. Terminal elevators on the Atlantic and Gulf coasts export
Georgia-produced corn, soybeans and soybean products, further drawing on locally available
supplies. Beyond the months immediately following harvest, Georgia's cash prices, especially for
purchased corn, are in essence Midwest spot prices plus the cost of transportation. Cash prices
usually exceed the nearby futures and the basis tends to be strong.

USING BASIS TO INCREASE GRAIN AND COTTON PROFITS

Farmers must predict changes in both the futures price and the basis to select the "best" marketing
alternative (Figure 9). A sound knowledge of basis contributes to improving three related marketing
decisions:
1) the choice of the marketing alternative and buyer to be used;
2) the evaluation of cash market contract offers; and
3) the decision about timing of when the sale should be made.
A four-quadrant crop price decision chart may be useful in selecting the possible marketing
alternatives (Figure 10). The decision quadrant is based upon your expectations of the direction of
movement in the basis and futures market prices.

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Figure 9. Commodity marketing alternatives

The upper-right hand quadrant of Figure 10 assumes that the futures price is increasing an

basis is weakening of movement in prices. Under these conditions, the cash market price could be
increasing, decreasing or remaining constant depending upon how rapidly the basis is weakening.
The actions listed in the upper-right quadrant of Figure 10 will either offset the weakening of the
basis or capture any further increase in the futures market.

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Figure 10. Crop pricing decision chart

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 Figure 11.
Futures prices
rising and a
weakening basis

The basis contract only fixes the basis at the current level. minimum price contract fixes the
basis and captures any subsequent rise in the futures market. The third action, selling in the cash
market and replacing the cash position with an equal position in the futures or options market,
eliminates basis, concerns and focuses only on action in these markets. Results obtained depend
upon subsequent futures market price movements. If the market continues to rise, increased returns
can be realized. However, the long (buy) futures position entails considerable downside price risk
if the futures market price falls. The purchase of the call option would limit the downside futures
market price risk to the amount of the premium paid for the option. A call option gives the holder
of the option the right to purchase the commodity at a future time and at a set price. These strategies
provide leverage to the seller since control of a futures or options contract requires a margin or
premium that is considerably less than the market value of the commodity the contracts represent.
The lower right quadrant of Figure 10 represents the situation when futures market prices are
failing and basis is weakening. This means cash prices are falling faster than futures prices and is
the worst possible situation for a farmer (Figure 12). All the actions listed in the lower right
quadrant of Figure 10 eliminate basis concerns. Cash sales and cash forward contracts complete the
marketing action for the commodity priced.

Figure 12.
Futures prices
rising and a weakening basis.

Selling in the cash market and replacing the cash positio

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n with an equal position in the futures or call option market eliminates basis concerns and focuses
only on action in these markets. Results obtained depend on movements in futures market prices.
If the market continues to fall, increased returns can be realized. The short (sell) futures position
entails considerable potential upside price, risk if the futures market rises. The purchase of the put
option would limit upside futures market risk to the amount of the premium paid for the option. A
put option gives the option holder the right to sell the commodity in the future at a set price. These
strategies also provide leverage to the seller as discussed earlier.
In the lower left quadrant, futures market prices are falling and basis is strengthening (Figure
10). In this situation cash prices may be failing slower than the futures, remaining steady or possibly
even increasing slightly (Figure 13). The production and storage hedging action will trade the risk
of further futures market declines for the risk that the basis will weaken. If the basis were to
continue to strengthen, a better price can be realized. In this strategy, the odds are that even if the
basis were to weaken, it would weaken by less than the likely fall in the futures price. If the basis
should weaken in the future, the actual price received will be less than expected when the hedge is
established, but only by the amount of the change in the basis.
Purchasing a put option (the right to sell) will still retain the risk of basis change as with a
hedge, but it establishes a minimum price while retaining the ability for gain if futures prices should
rise. The minimum price contract acts in the same fashion as a put option except that the seller is
obligated to deliver to the writer of the contract while with the put option the seller can deliver the
product to any buyer. The minimum price afforded by these alternatives will be less than a cash sale
or a forward cash contract.

Figure 13.
Falling futures
prices and a strengthening basis

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 Selling cash and replacing the cash position with an equal position in the futures or call
option market eliminates further potential basis gains or losses and focuses only on action in these
markets. Results will be the same as those described earlier for the actions in the lower right
quadrant of Figure 10.
In the upper-left quadrant, the futures market prices are rising and/or the basis is improving.
Figure 14 shows this set of price changes. This is the best of all worlds for farmers as the cash
market rises faster than the futures market. There are many alternatives available to manage this
situation. Perhaps the easiest is to wait before selling until the basis becomes steady and the futures
market stops rising. The risk is failing to identify these signals and missing out on a good sales
opportunity. Storage is a similar strategy but carries the added costs associated with the activity.
Delayed pricing contracts can be used to transfer the cost and risks of storage to the buyer while
retaining the ability to further watch the market. This is because ownership of the commodity
changes hands when the contract is signed but the final price determination is made at a later date.
These alternatives retain basis and futures market price risks.

Figure 14. Rising future

prices and a strengthening basis

A put option still has the risk of basis change associated with it but establishes a minimum
price while retaining the ability to gain if futures market prices continue to rise. It therefore offers
protection against futures prices falling. The minimum price contract acts in much the same fashion
as. a put option except that the seller is obligated to make delivery to the contract writer. The
minimum price afforded by this is less than in a cash sale. The basis contract establishes the basis
at the current level and eliminates a chance for further basis gain or loss. The risk of a futures price
changing is still apparent with the basis contract.
The last set of alternatives is to make a sale in the cash market or with a cash market forward
contract. This eliminates all downside futures and basis risks. The alternative of replacing the cash
position with an equivalent position in the long futures or call option markets offers the opportunity
to realize a higher selling price if the markets should continue to rise. Basis risk is eliminated and
leverage is realized. However, the long futures position entails considerable potential downside
price risk if the futures market falls. The purchase of the call option would limit downside futures
market risk to the amount of the premium paid for the option.

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BASIS AND CASH CONTRACTS

Knowledge of the historical cash basis can be very useful in evaluating cash forward, delayed
pricing and basis contract offers. The historical cash basis is the standard against which contract
offers should be compared. The basis offered by the contract should be close to the expected basis
at delivery time or at the pricing out of the deferred price contracts.
In practice, the offered basis normally is less than the expected cash basis because of the costs
and risks incurred by the buyer. Typically, the buyer hedges in the futures market a purchase made
via a contract and in effect hedges for the seller. There is a cost to the buyer associated with the
hedge. The buyer also faces the risk of default by the seller and this risk must be compensated.
These costs are passed along to the seller and the contract basis is less than the expected basis by an
amount needed to cover these buyer costs.
The cash market forward contract basis changes as the buyer evaluates the local crop
conditions and accumulates purchases. Normally, the contract basis is weak early in the year and
strengthens as harvest approaches. In Figure 15, an example from Bulloch County, the expected
harvest cash basis is -$.15. Typically, the basis is weak early in the year during the planting season
because there is little buying or selling interest. As planting intentions become apparent in March,
the basis typically strengthens as buyer competition for forward sales increases, but bids may weaken
slightly during planting season as selling interest intensifies. As the crop progresses and harvest time
nears, the basis strengthens until contracts offered shortly before harvest have a basis near the
expected cash market basis.

Figure 15. Typical

Georgia soybean cash
forward contract basis

CONTRACT BASIS PATTERN

Notice in Figure 15 that the basis strengthens rapidly from January to March by about ten
cents per bushel. Based on this behavior by buyers, it would not appear prudent to cash forward
contract during the first quarter of the year. Forward pricing should be accomplished by other means
during this time. After the basis strengthens it remains fairly steady during the growing season,

15
showing only about a nickel improvement. This would appear to be a small premium to pay for
being able to shift price risk in the cash market during the growing season.
Implications for contracting appear to be that it can be used to shift price risk without
forfeiting substantial basis gains. This is especially true when the costs of other price-risk-shifting
alternatives such as hedging or the purchase of a put option are compared to the foregone basis gains.
In addition, the basis gains are never guaranteed, only potential.

BASIS AND STORAGE DECISIONS

The decision of whether to place a crop in storage should be based on the potential returns
to be obtained. Returns to storage can come from price increases in the futures market and gains
from a strengthening basis. Usually, futures prices increase from the harvest period throughout the
marketing year, but this does not always happen. Even when prices do rise they may not rise enough
to offset the cost of storage. Basis invariably increases due to the factors discussed so far. Basis
gains can cover a large share of the cost of storage, leaving only a small portion to be covered by
seasonal futures market price increases.
Figures 6, 7 and 8 illustrate the typical basis patterns for Georgia soybeans, corn and wheat.
Substantial basis gains in these commodities occur during the marketing year. A large share of the
gain occurs early in the year, usually within four to six months of harvest. After that, basis gains are
small.
The implications for storage are that in terms of potential basis gains, most crop storage in
Georgia should be short-term in nature. After the initial strengthening of the basis, returns to storage
must be covered by gains in the futures market; a prospect that is not at all certain.

BASIS GAIN AND SHORT-HEDGING STORAGE

A short hedge in the futures market can be used to ensure a return to storage if it is available
in the market. For example, in late August during com harvest, the September futures contract is at
$2.25, the local cash basis is +$.05 and the March corn futures contract is at $2.40. Typically in early
March the normal Georgia corn basis is +$.30. In this case, the choice is between accepting $2.30
now or using a storage hedge in an attempt to generate a $2.70 price in early March providing a $.40
return to cover the storage activity.
Storage costs for corn are about $.04 per month and the cost for carrying the corn until early
March would be about $.24. Hedging costs would be about $.05 per bushel. A storage hedge would
project a net price of $2.40 + $.30 - $.24 - $.05 = $2.41 per bushel. Basis gain of $.25 ($.30 - $.05)
is more than enough to offset the storage costs and the market provided carry of $.15 ($2.40 - $2.25)
more than covers the hedging costs and provides a return to the risk of storage. The storage hedge
would provide a net return of $.ll ($2.41 - $2.30) compared to cash sale at harvest.

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 LIVESTOCK BASIS

ESTIMATING AND INTERPRETING LIVESTOCK BASIS

Livestock basis is calculated as the cash price for the livestock in question less the nearby
futures price. Since livestock are not storable, only the futures price for the futures contract maturing
closest to but not before the cash marketing date is of interest.
Unlike the grain and cotton markets, storage cost do not relate the various futures contract
prices during the marketing year to one another. Therefore, a typical tabulation of livestock basis
shows only the cash marketing time-periods and the basis calculated by subtracting the closest
futures contract price from the cash price.

FORECASTING THE LIVESTOCK BASIS

Several studies have shown that the use of the recent three- or five-year average of the local
basis, adjusted for quality differences, is as accurate a forecast of the basis as more sophisticated
forecast techniques. The important information from historical basis studies is the variability in the
cash/futures difference. If, in April, the difference between hogs sold locally and the futures price
has averaged $ -.50/cwt. during the last five years but has varied from .50/cwt above futures to 2.00
below, it may be expected that local hogs will bring $.50/cwt. less than the April futures price in the
future. However, there is some chance of receiving a price as much as $2.00/cwt. less than the
current futures price or $.50/cwt. above futures.
Historical basis information would normally be summarized in a table such as Table 3,
which displays the average basis for the time period and the variability of the basis. Extension
livestock basis tables show the average, best and worst basis estimates as well as probable range
estimates. The probable range estimates are calculated from the statistics for the standard deviation.
Approximately two-thirds of the actual cash and futures price differences were within the average
plus the probable range and the average less the probable range. The probable range provides
another measure of the variability of the basis and the potential difficulty in predicting livestock
basis.

LIVESTOCK BASIS PATTERNS

Livestock basis in Georgia is not constant throughout the year. Figures 16 and 17 show the
typical seasonal basis pattern for feeder cattle and market hogs. Most of the seasonal pattern is due
to differences in Georgia's calving/marketing and farrowing/marketing patterns. The strongest feeder
cattle basis occurs during the spring, and weakens into the fall and early winter. Market hog basis
shows a relatively strong basis in late winter before falling into the weakest basis period around May.
The basis then normally strengthens into fall, peaking in September.

Figure 16.

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 Changes in the
cattle basis over time

Figure 17.
Changes in the hog
basis over time.

FACTORS AFFECTING LIVESTOCK BASIS

In general, three factors determine Georgia's livestock basis: time, location and quality. The
time dimension of the basis is usually limited to the time the livestock are expected to be delivered
on the local cash market and the nearby futures. During the delivery period of a contract (usually
the first of the contract month to roughly the twentieth of the month), the cash price at the futures
market delivery point and the futures price should differ by only a small amount. Thus, the basis
difference during the futures market delivery contract month reflects only location or quality
differences. Because livestock are not storable, basis differences in months other than the delivery
month will also reflect the general direction expected in prices. For example, the difference between
the cash price of hogs in January (for which there is no futures contract) and the February futures
contract will depend on the futures market anticipation of the supply of and demand for hogs in
February as compared to the actual supply and demand in January. If the market expected an

18
increase in hog supplies from January to February (and thus a lower hog price in February), the
February futures price could be lower than the January cash price. This would result in a positive
January basis (with the January cash price higher than the nearby February futures). The opposite
situation could result in a negative basis (with a cash price lower than futures). As the cash-
marketing time approaches the futures contract delivery time, the basis becomes more predictable
because the market direction is not considered. Note the large "probable ranges" for the non-delivery
hog contract months in Table 3.

Table 3. Georgia direct hog market basis comparisons for U.S. Grade No. 1 and 2; 200 to 250
pounds, 1986-1990.

Average Probable Best Yearly Worst

basis range Basis Yearly Basis
Month ($/Cwt) ($/@) ($/@) ($/Cwt)
January 2.26 +2.54 1.73 -4.33
February* 1.71 +1.87 0.32 -3.94
March 0.83 + 2.84 2.86 -4.01
April* 2.81 + 2.22 0.24 -5.48
May 4.65 + 3.11 -0.38 -7.78
June* 3.07 +1.66 -1.13 -4.88
July* 1.07 + 2.29 1.83 -2.22
August* 0.64 +1.60 0.75 -2.29
September + 2.90 +1.87 5.02 +1.77
October* - 0.11 +1.30 1.05 -0.85
November - 2.07 + 2.72 1.15 -4.75
December* - 3.60 + 1.43 -1.16 -4.66
*Denotes live hog futures contract month

Location differences in basis may also exist. Anything affecting the local supply and demand
balance relative to the futures market delivery point affects the basis. For instance, the opening or
closing of a local slaughter plant may have little impact on the national demand for hogs, which
determines the futures price, but can have a great impact on the price received locally. The prices
in Table 4 illustrate the dramatic effect the closing of a major Georgia hog slaughter plant in July of
1987 had on the Georgia hog basis. Delays in local marketings due to field work demands in the
spring or inclement weather in the winter can also affect the basis, because local buyers may be
willing to pay more relative to the national market price due to a reduced local supply.

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Table 4. Georgia prices for 210 - 240 pound U.S. Grade 1 and 2 hogs direct to slaughter plants,
and April futures prices before and after a major hog slaughter plant closing in July 1987

Direct Market April Futures

Hog Price Live Hog Price Basis
Date ($/Cwt) ($/Cwt) ($/Cwt)
4/5/86 40.35 40.49 - 0.14
4/12/86 39.15 40.39 - 1.24
4/19/86 39.55 41.32 - 1977
4/4/87 49.30 48.26 + 1.04
4/11/87 51.30 51.36 - 0.06
4/18/87 52.90 53.01 - 0.11
4/2/88 40.15 45.67 - 5.52
4/9/88 40.05 45.44 - 5.39
4/16/88 40.05 45.27 - 5.22
4/l/89 37.51 41.44 - 3.93
4/8/89 36.35 40.22 - 3.88
4/15/89 35.55 40.05 - 4.50
4/7/90 51.25 54.48 - 3.23
4/14/90 52.15 55.62 - 3.47
4/21/90 52.95 56.83 - 3.88

Location differences in the basis other than those mentioned above are usually rather
predictable over time. Transportation costs involved in moving livestock from one market to
another. limit all location basis differences. While the hog slaughter plant closing in Georgia in 1987
reduced the basis, the limit to this weakness was set by the cost of shipping hogs to plants outside
of Georgia. The transportation cost of moving feeder cattle from Georgia to the feedlot states is the
primary reason for a large negative feeder cattle basis in Georgia.
Quality is another determinant of basis. The futures market price is set for a specific quality.
The basis estimate should reflect any anticipated discount or premium due to delivery of a differing
quality of livestock locally. For instance, the basis estimate should reflect any discount associated
with heavy or light hogs or grade differences not accounted for in the original basis price
comparison. Normally, the use of the current discount, or premium, quality difference will provide
an adequate forecast of the quality component of the basis.

USING THE LIVESTOCK BASIS TO INCREASE PROFITS

Knowledge of the livestock basis can help producers in three ways: evaluation of hedging
or floor pricing opportunities, evaluation of cash contract opportunities, and cash market timing. By
properly estimating the basis for the quality and location of the livestock to be delivered, Georgia
producers can use either the futures market or the commodity options market to forward price their
cattle or hogs. If the basis is underestimated, producers may fail to take advantage of potential profit
opportunities. Likewise, producers may find forward prices initiated at what were though to be
profitable prices result in losses due to an overestimation of the basis.
Producers who wish to forward price livestock and have forward cash contracts available

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need an understanding of the basis to evaluate their marketing alternatives. Typically, cash contracts
are offered at basis levels less than the historical basis, because the contractor is assuming the risk
associated with guaranteeing the basis and the cost of hedging in the futures or option markets. In
order to determine whether the contract is a "good deal" as compared to forward pricing directly in
the futures or option, the difference in the contract's basis and the estimated basis should be con-
sidered. If the difference is large enough, the producer may find it advantageous to do the forward
pricing himself. For instance, a producer is offered a forward cash contract to deliver a truckload
lot of feeder steers at $80/cwt. in April. If the April feeder cattle futures contract on this day was
$85/cwt., the contract's implied basis is -$5.00/cwt. If the producer's historical basis difference has
been -$1.00/cwt., the producer has to decide if the $4.00/cwt. difference justifies contracting because
he could forward pricing by trading the feeder cattle futures contract himself (hedging). If he
chooses to hedge himself, then he will take the risk that the basis turns out to be worse than normal.
However, he would not lose money compared to the contact unless the basis was worse than
-$5.00/cwt.
The basis may also be used to help producers decide when to move their livestock. If the
basis is stronger than normal, livestock may be marketed slightly ahead of their estimated market
period to take advantage of the favorable basis. Alternatively, weak basis may be a signal to delay
marketings if possible, with the idea that the basis is likely to return to a more normal level. In either
case, the cost of gain as well as the basis movement must be considered.

SUMMARY

An understanding of basis and the adaptation of marketing strategies that use that knowledge
can increase receipts from commodity sales in Georgia. Basis data should be maintained and
followed as a standard practice by Georgia farmers. The time spent following the basis and using
basis patterns as a guide to marketing decisions can earn a very high return.

Bulletin 981 /Revised February, 1991

The University of Georgia and Ft. Valley State College, the U.S. Department of Agriculture and
counties of the state cooperating. The Cooperative Extension Service offers educational programs,
assistance and materials to all people without regard to race, color, national origin, age, sex or
disability.

An Equal Opportunity Employer/affirmative Action Organization Committed to a Diverse Work Force

Issued in furtherance of Cooperative Extension work, Acts of May 8 and June 30, 1914, The
University of Georgia College of Agricultural and Environmental Sciences and the U.S. Department
of Agriculture cooperating.

Gale A. Buchanan, Dean & Director

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