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 <a href="mailto:[email protected]" target="_blank">[email protected] </a>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. 42 9/4/2018 Risk is ever present… How do we choose to address? Accept it <ul style="display: flex;"><li style="flex:1">Don’t Fear it </li><li style="flex:1">Manage it </li></ul>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, Machinery, Trucks Family & Employees Insurance Health & Safety 3 9/4/2018 Another Critical Business Risk: PRICE!!! Grains Oilseeds More Likely & More Frequent! Livestock Know Your Price Risk & Manage It! 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 Rights to Buy or Sell at Price Levels with Opportunity to Improve Locked-in Buying & Selling Price Levels Variety of Contracts With Physical Delivery Requirements Creative Financial Products With Pricing Flexibility **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 <ul style="display: flex;"><li style="flex:1">Local Cash Basis </li><li style="flex:1">Global Futures Price </li></ul>Higher Stronger No change Lower No change Weaker 6 9/4/2018 What is a BUYER’S Market Risks? Buyer’s Cash Basis Global Benchmark Futures Price <ul style="display: flex;"><li style="flex:1">Higher </li><li style="flex:1">Stronger </li></ul>What is a SELLER’S Market Risks? <ul style="display: flex;"><li style="flex:1">Global Benchmark Futures Price </li><li style="flex:1">Seller’s Cash Basis </li></ul><ul style="display: flex;"><li style="flex:1">Weaker </li><li style="flex:1">Lower </li></ul>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% <ul style="display: flex;"><li style="flex:1">Annualized Volatility </li><li style="flex:1">68% Probability Price Range </li></ul>10% 20% 30% $3.60 - $4.40 $3.20 - $4.80 $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 Management Remember what I said earlier ??? Stated Simply Creates OPPORTUNITY Basis & Hedging Theory 9 9/4/2018 Basis Key to Successful Hedging Local Supplier or Buyer Price quote Global Benchmark Price quote Local Cash Relative to Futures Cash Price Futures 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 Customers should become Students of Basis! Cash minus Futures Locational & Quality Seasonal & Historical Trends Differences BASIS Buyers want Sellers want Weaker Stronger Less Volatile 10 9/4/2018 Basis Movement & Opportunity +30 +20 +10 0Strengthen Cash Gains Relative* to Futures More positive or Weaken Cash Declines Relative* to Futures Less positive or Less negative More negative Benefits Short Hedgers Benefits Long Hedgers -10 -20 -30 Commodity Buyers Commodity Sellers *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) <ul style="display: flex;"><li style="flex:1">Maximum </li><li style="flex:1">Minimum </li><li style="flex:1">Average </li></ul>160 140 120 100 80 60 40 20 0Week 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 OTC Swaps Local 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 Market Futures Market 13 9/4/2018 Types of Hedgers • Long hedger • Risk of rising prices • Attempt to achieve target prices • Short the basis – wants basis to weaken Consumer (buy-side) • Short hedger Producer (sell-side) • Risk of falling prices • Attempt to cover production costs & profit • Long the basis – wants basis to strengthen Futures Industry Foundation 14 9/4/2018 Futures Contract: Defined Corn 5,000 bu. = 127 m.t. Legally binding agreement to accept delivery of or make delivery of a Wheat 5,000 bu. = 136 m.t. quantity standardized _______ and ______ quality Soybeans: 5,000 bu. = 136 m.t. place of a commodity to a standardized _____ time price during a standardized ____ period for a ____ Soybean Meal 100 short tons = 92 m.t. discovered in an organized futures exchange. Economic Functions of Futures Price Discovery Which impacts the greatest 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 Customers Cash Market Speculator Cash Market Hedger <ul style="display: flex;"><li style="flex:1">Risk </li><li style="flex:1">Liquidity </li></ul><ul style="display: flex;"><li style="flex:1">Risk </li><li style="flex:1">Liquidity </li></ul>Speculators provide what hedgers need! LIQUIDITY 16 9/4/2018 Speculators’ Impact on Hedgers Corn Market Liquidity 3.80 3.85 Seller’s Offer Hedgers Only Buyer’s Bid 3.81 New Bid 3.84 Better Offer Speculator 3.82 New Bid 3.83 Better Offer Speculators 3.82 1/4 Best Bid 3.82 1/2 Best Offer SClosing-out a Futures Position Offset Offset: Taking a position opposite to your initial position • Initial futures position creates market obligation • Offset removes market obligation Initial Position Long Futures Sell Identical Futures later OFFSET Or Initial Position Short Futures Buy Identical Futures OFFSET 17 9/4/2018 Closing-out a Futures Position Delivery Transfer of a physical commodity or cash-settlement •Only about 1% of Futures volume ends with delivery •Great majority are “offset” •Initiated “only” by the Seller (short) •Short must have approved “regular for delivery” status Assigned to “oldest” long ••Specific Terms & Procedures •Varies by commodity – shipping certificates, warehouse receipts •See Exchange Rule Book for details ••Cash Price & Futures Price Convergence •Due to threat of delivery in futures contract Not economically or physically feasible for the Buyer (long) •Seller makes delivery decisions: specific date, quality, location CBOT Grain & Oilseed Futures Delivery 3-Day Process* First Delivery Day ••••First business day of the contract month First Notice Day Short delivers the shipping certificate to the long •••Last business day of calendar month prior to delivery month. Example: June for July contract. First Position Day Long makes payment to the short by 1:00 p.m. •Business day prior to last business CME Clearing notifies “oldest long” by 7:00 a.m. that delivery will take place day of calendar month prior to delivery month. Example: November for December contract If delivery day is a bank holiday, payment is made by 9:30 a.m. on the next banking day. Short invoices the long by 4:00 •Short positions: First day that short positions can initiate the delivery process by notifying CME Clearing. Only shorts that have “regular for delivery” status p.m. *Note: This 3-day process for first delivery also applies to deliveries up to and including the last delivery day. The last delivery day is the 16th of the contract month ••Long positions: Ranked according to the amount of time they have been long. Oldest is ranked first Daily price limits are removed for remainder of trading of the delivery contract month 18 9/4/2018 Financial Integrity of Futures Clearing Models Bilateral versus Cleared CLEARED TRADE: A trade guaranteed by Futures Commission Merchants (FCM) who are members of a clearing house BI-LATERAL TRADE: A trade executed between two parties without the benefit of a central clearing house. Source: CME Group 19 9/4/2018 Exchange Clearing Services • Eliminates Counter Party Risk  Buyer to every Seller and Seller to every Buyer • Adjust Trading Accounts Daily  Marked to Market • Facilitates Trading Processes  Futures Delivery  Option Exercise Central Counterparty Clearing Source: CME Group 20

Commodity Risk Management Techniques & Hedge

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