Understand Basis Contracts for Opportunity to Maximize Profit

ISU Extension and Outreach publication explains how basis works, when it can be used

November 20, 2017, 10:55 am | Chad Hart

AMES, Iowa – Marketing grain by using basis contracts provides more flexibility in how farmers market their grain and profit from their crop.Understand Basis Contracts

“Typically, when there is a cash price for something, it is thought of as one price,” said Chad Hart, associate professor and extension economist with Iowa State University. “Basis contracts break that price down into two components – the futures price and the basis. So instead of trying to maximize just one component, farmers can try to maximize both. This gives them more flexibility and an opportunity to get a better cash return than just capturing the highest cash price.”

Knowing how to use basis contracts to lock in a sales price for grain is the focus of Iowa State University Extension and Outreach publication “Understanding Risk in Basis Contracts” (FM 1891). The publication was revised and updated by Chad Hart, associate professor and extension economist with Iowa State.

“Basis can be a great signal to help farmers figure out where to sell their crops and improve profitability,” Hart said. “Basis can also help provide a signal as to who their customers are and if demand is growing or shrinking.”

Basis contracts differ from price-later contracts because the basis (the difference between the local cash price and futures price) is established when the contract is signed and because elevators or processors may pay a portion of the values of the grain at the time it is delivered to the buyer.

“Basis contracts give farmers an opportunity to lock in a basis when it is advantageous to them,” Hart said. “That gives them the chance to improve their bottom line.”

There are also potential pitfalls when using this type of marketing tactic.

“The risk by using a basis contract is that I’ve locked in one piece of the price but the other part could still decline,” Hart said. “Once committed to that buyer, if a better price comes along later on, I can’t move those same bushels to a different buyer for a better price.”

Even with that risk, selling grain through basis contracts should be part of a farmer’s overall marketing plan.

“You want to have a wide variety of tools – sell for cash, sell forward, hedge, basis contract – on your marketing menu and to use those tools when it makes sense,” Hart said. “Given the volatility we see in prices, the more choices farms have to market their grain the better off they are.”

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