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Commodity Risk Management Techniques & Hedge

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Commodity Risk Management Techniques & Hedge 9/4/2018 COMMODITY RISK MANAGEMENT TECHNIQUES & HEDGE ACCOUNTING CHANGES September 5, 2018 To Receive CPE Credit • Individuals . Participate in entire webinar . Answer polls when they are provided • Groups . Group leader is the person who registered & logged on to the webinar . Answer polls when they are provided . Complete group attendance form . Group leader sign bottom of form . Submit group attendance form to [email protected] within 24 hours of webinar • If all eligibility requirements are met, each participant will be emailed their CPE certificate within 15 business days of webinar 1 9/4/2018 Bryan Wright Partner | BKD Indianapolis I 317.383.5471 Allen Douglass Regional Director | INTL FCStone Financial, Inc. FCM Division Indianapolis l 317.732.4660 Disclaimer The trading of derivatives such as futures, options, and over-the-counter (OTC) products or “swaps” may not be suitable for all investors. Derivatives trading involves substantial risk of loss, and you should fully understand those risks prior to trading. Past financial results are not necessarily indicative of future performance. All references to futures and options on futures trading are made solely on behalf of the FCM Division of INTL FCStone Financial Inc., a member of the National Futures Association (“NFA”) and registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a futures commission merchant. All references to and discussion of OTC products or swaps are made solely on behalf of INTL FCStone Markets, LLC (“IFM”), a member of the NFA and provisionally registered with the CFTC as a swap dealer. IFM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of IFM. This material should be construed as the solicitation of trading strategies and/or services provided by the FCM Division of INTL FCStone Financial Inc., or IFM, as noted in this presentation. Neither the FCM Division of INTL FCStone Financial Inc. nor IFM is responsible for any redistribution of this material by third parties or any trading decisions taken by persons not intended to view this material. Information contained herein was obtained from sources believed to be reliable, but is not guaranteed. These materials represent the opinions and viewpoints of the author, and do not necessarily reflect the opinions or viewpoints of the FCM Division of INTL FCStone Financial Inc. or IFM. All forecasting statements made within this material represent the opinions of the author unless otherwise noted.Factual information believed to reliable, was used to formulate these statements of opinion; but we cannot guarantee the accuracy and completeness of the information being relied upon. Accordingly, these statements do not necessarily reflect the viewpoints employed by the FCM Division of INTL FCStone Financial Inc. or IFM. All forecasts of market conditions are inherently subjective and speculative, and actual results and subsequent forecasts may vary significantly from these forecasts. No assurance or guarantee is made that these forecasts will be achieved. Any examples given are provided for illustrative purposes only, and no representation is being made that any person will or is likely to achieve profits or losses similar to those examples. Reproduction or use in any format without authorization is forbidden. © Copyright 2018. All rights reserved. 4 2 9/4/2018 Risk is ever present… How do we choose to address? Accept it Don’t Fear it Manage it Conquer it If you don’t manage risk, you are assuming risk If you are assuming risk, you are speculating!!! Normal Business Risks Buildings & Facilities Equipment, Family & Machinery, Insurance Trucks Employees Health & Safety 3 9/4/2018 Another Critical Business Risk: PRICE!!! Grains Oilseeds More Livestock Likely Know Your & More Price Risk & Manage It! Frequent! Energy Interest Rates & FX HOWEVER, WITHOUT PRICE RISK MANAGEMENT… Things can get Real UGLY Real fast! And Bottom Lines & Margins Can Melt Away! 4 9/4/2018 Is Price Risk Management Difficult? NO! Just remember, complex concepts stated simply creates opportunity! Success favors the Prepared. Tools to Manage Price Risk Locked-in Buying & Selling Rights to Buy or Sell at Price Levels Price Levels with Opportunity to Improve Creative Financial Products Variety of Contracts With With Pricing Flexibility Physical Delivery Requirements * *OTC products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of IFM. 5 9/4/2018 What is Market Risk? Uncertainty! Types of Market Risk Global Futures Price Local Cash Basis Higher Stronger No change No change Lower Weaker 6 9/4/2018 What is a BUYER’S Market Risks? Global Benchmark Futures Price Buyer’s Cash Basis Higher Stronger What is a SELLER’S Market Risks? Global Benchmark Futures Price Seller’s Cash Basis Lower Weaker 7 9/4/2018 Price Volatility Source: CME Group What is Volatility? Example: March 2019 Corn Futures at $4.00 Compare Market Volatility: 10%, 20%, 30% Annualized Volatility 68% Probability Price Range 10% $3.60 - $4.40 20% $3.20 - $4.80 30% $2.80 - $5.20 At what volatility level is your risk the greatest? At what volatility level is your opportunity the greatest? Note: 2 Standard Deviations is 95% probability and 3 Standard Deviations = 99% probability 8 9/4/2018 Price Risk Management – Summary Price Risk Remember Management what I said earlier ??? Stated Simply Creates OPPORTUNITY Basis & Hedging Theory 9 9/4/2018 Basis Key to Successful Hedging Local Supplier Global Local Cash or Buyer Benchmark Relative to Price quote Price quote Futures Cash Futures Price Price Basis Q. If you have more than one “cash” quote, how many basis tables are needed? A. Each cash market supplier represents a different basis. Basis Concepts Merchandisers & Their Cash minus Customers Futures should become Seasonal & Locational Students of Historical & Quality Basis! Trends Differences BASIS Buyers Sellers want want Weaker Stronger Less Volatile 10 9/4/2018 Basis Movement & Opportunity +30 +20 Strengthen Weaken Cash Gains Relative* to Futures +10 Cash Declines Relative* to Futures More positive or Less positive or Less negative 0 More negative Benefits Short Hedgers Benefits Long Hedgers -10 Commodity Sellers Commodity Buyers -20 -30 *Basis can strengthen or weaken regardless of the price direction Use of Basis in Risk Management Gulf Export Price - Nearby Corn Futures Basis (Sample 10 year period) Maximum Minimum Average 160 140 120 100 80 60 40 Basis (Cents per Bushel) (Cents Basis 20 0 1-Jul 8-Apr 7-Oct 1-Jan 3-Jun 9-Sep 4-Nov 2-Dec 15-Jul 29-Jul 6-May 22-Apr 21-Oct 15-Jan 29-Jan 17-Jun 12-Feb 26-Feb 11-Mar 25-Mar 12-Aug 26-Aug 23-Sep 18-Nov 16-Dec 30-Dec 20-May Week of the Year 11 9/4/2018 Basis Summary • Cash price relative to a Futures price • Usually less volatile than Futures • Seasonal & Historical trends • Purchasing & Sales Tool • Can have a negative or positive value • Buyers want basis to weaken over time • Sellers want basis to strengthen over time • Key to successful Price Risk Management True Hedge – Consists of Two Parts Futures, Options or Local OTC Swaps Cash Market 12 9/4/2018 Hedge Concepts Fact: Most cash markets and futures markets move up and down together Not necessarily in equal amounts Relationship between a cash & a futures price: Correlation Hedge Positions Opposite positions in Cash market and Futures market Hedge Results Loss in one market is offset by a gain in the other market Regardless of price direction, the result is the same! The “TRUE” hedge result is the combined results of the cash and futures positions HEDGED RESULTS Loss in One Market is Offset by a Gain in the Other Cash Futures Market Market 13 9/4/2018 Types of Hedgers • Long hedger Consumer • Risk of rising prices • Attempt to achieve target prices (buy-side) • Short the basis – wants basis to weaken • Short hedger Producer • Risk of falling prices • Attempt to cover production costs & profit (sell-side) • Long the basis – wants basis to strengthen Futures Industry Foundation 14 9/4/2018 Futures Contract: Defined Corn 5,000 bu. = Legally binding agreement to accept 127 m.t. delivery of or make delivery of a Wheat 5,000 bu. = 136 m.t. standardized _______quantity and ______quality Soybeans: of a commodity to a standardizedplace _____ 5,000 bu. = 136 m.t. during a standardized ____time period for a price____ Soybean Meal discovered in an organized futures exchange. 100 short tons = 92 m.t. Economic Functions of Futures Price Which impacts the greatest Discovery number of people? Price Reference & Cash Contracts Futures Markets Which is the most important economic function? Risk Management For Customers 15 9/4/2018 Price Discovery: Supply & Demand • Prices are Discovered • Prices are NOT set by the Exchange • Closest form of “perfect competition” • Two-way Price Impact • Transparent Prices Types of Traders Merchandisers & Their Cash Market Cash Market Customers Hedger Speculator Risk Liquidity Risk Liquidity Speculators provide what hedgers need! LIQUIDITY 16 9/4/2018 Speculators’ Impact on Hedgers Corn Market Liquidity 3.80 3.85 Buyer’s Bid Hedgers Only Seller’s Offer 3.81 Speculator 3.84 New Bid Better Offer 3.82 Speculators 3.83 New Bid Better Offer 3.82 1/4 S 3.82 1/2 Best Bid Best Offer Closing-out a Futures Position Offset Offset: Taking a position opposite to your initial position • Initial futures position creates market obligation
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