By SEAN ELLIS
Commodities futures markets are used by many farmers to hedge their risks by locking in crop prices.
It's a type of financial contract used to ensure a minimum price is received for an agricultural commodity even if prices fall in the future.
When a farmer, grain elevator, grower co-op or other entity enters into a futures contract, they're agreeing to deliver or buy a specific quantity of a commodity on a future date at a specific price.
In the case of farmers using futures to hedge, the contracts are paper transactions where no actual grain trades hands.
Contracts typically call for delivery in either Chicago or Kansas City. Because farmers prefer to sell to local elevators at the best available cash price to keep delivery costs low, they require two futures contracts.
They first agree to sell at a specified price. As the delivery date draws near, they agree to buy an equal amount of grain for the price they expect to receive at the local elevator. The second contract replaces their original position in the market, freeing up their crop for local sale.
In a simple example, a farmer sells a contract to deliver 1,000 bushels of wheat at $5 a bushel at a future date. Later, if the cash price of wheat increases $1, the farmer buys another contract agreeing to purchase wheat at $6 a bushel.
While the farmer loses $1 a bushel in the futures transaction, that loss is offset by a $1 a bushel gain in the cash transaction. The trade enables the farmer to realize the original $5 per bushel price.
"If the market goes up or down, it doesn't matter because you make it up on the cash market," Montana farmer Marty Klinker said.