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2. Now assume the same for a speculator who takes a long position on a
March futures contract at $59
• If the price increases to $65, the speculator sells for $59 and imme-
diately buys for $65, leading to a gain of $6 per barrel [$12,000 gain
in value for five contracts]
• If the price increases to $55, the speculator loses $12,000
4.2 Basis Risk
In practice, hedges are often not as straightforward as has been assumed in this
course due to the following reasons
1. The asset to be hedged might not be exactly the same as the asset under-
lying the futures contract
• actual commodity, weight, quality, or amount might differ
2. The hedger might not be exactly certain of the when the asset will be
bought or sold
3. Futures contract might need to be closed out before its delivery month
• many commodities do not have 12 deliery months
Basis is the difference between the cash price for the asset to be hedged and
the futures price. If the hedged asset is identical to the commodity underlying
the futures contract, the cash price and futures price should converge as delivery
nears. Changes in basis price do not impact the futures contract but do impact
the sales price for the producted to be hedged.
Below is a figure of the basis prices associated with Montana beef cows.
Notice the following: