futures contracts work somewhat well for farmers. There's a level of certainty provided and they are reducing their risk so that a low price at the end of the season doesn't ruin them (however they also don't profit from a higher price). As a farmer i would likely prefer to sell a certain percentage of my goods with a futures contract so that i can have less risk of financial ruin.
From a farmer's point of view, futures can allow for relatively cheap insurance against the agricultural product's price moving against you. You're basically negotiating the price of the product before it's ready to sell, with a standardized product on a global marketplace.
What about futures contracts? I didn't see that mentioned at all and I thought that was the primary means that farmers used to remove uncertainty over what they would be paid for their harvest?
Update: this is discussed in another sub-thread on this page.
All the commodities mentioned in the article have had active futures markets for decades. A farmer will typically sell contracts to deliver their crop as a hedge against the price moving against them during the season. https://en.wikipedia.org/wiki/Futures_contract
But wouldn't they want the futures market to have perfect information? So that the futures could be priced exactly right, which would mean the lowest possible price that counterbalances a down market perfectly?
I assume the farmers aren't trying to make money from the futures, they're just trying to not lose money. Their profits come from actually growing food. The futures are just there in case something bad happens. Right?
Interestingly enough the futures contract was invented by agricultural commodities traders to hedge against inclement weather.
But consider that many farmers only have a high school education, and are managing operations with millions in assets/debt, hundreds of thousands in revenue per year, and razor thin margins. A lot can go wrong.
Many understand the benefits and dangers of financing, but many don't.
The relationship between futures traders and farmers is pretty much identical to that between any kind of insurance company and its customers - it's a risk arbitrage transaction where the client (farmers in this case) are sacrificing profit in expectation for a flatter outcome curve which in a properly priced market yields higher utility in expectation, since utility as a function of profit is concave for an individual farmer and much closer to linear for a well-capitalized market maker.
I'd venture farmers make half or more more of their money on futures markets. Argi-business is a global market and optimal prices for your commodities don't necessarily conform to your local conditions/crops/etc.
I can't speak for all farmers, but my family owns a farm and the futures market is huge in it generating money.
You can use the futures markets to hedge against bad crop yields, lock in profits for accounting and cash flow purposes, inform what crops you are going to grow. It's immensely valuable.
Technically that's the original use case of futures contracts - you pay now, and lock the price. You might lose some (due to prices falling down, supply not fulfilling the contract) or win some (due to issues in supply, prices going up, etc.).
On the other hand, the supplier gets money now, not some time in the future (like after harvest) and this provides a different kind of cash flow that doesn't invoke debt (usually).
And then there's trading on the contracts all around, trying to get best prices :)
This is how futures contracts are supposed to work. The times when these contracts made the farmers extra money at the expense of the consumer should make up for this time.
Why? Wouldn't a farmer just buy the futures contract (or an option on it), then liquidate and use the profit to offset the loss on the spot purchase? I was under the impression that hedgers never take delivery.
True, and that's one of the reasons futures contracts spread beyond the agricultural sector, where they originated. The key difference with agriculture is that it's really easy to see how futures work--it's the model sector for futures--whereas in other sectors, they can be somewhat more nebulous.
In general/basics/origins, farmers only want to sell futures, because they actually have (intend to have) the commodity for physical delivery, and do want to physically deliver it.
So who is on the buy-side? Exclusively supermarkets/distributors, while exclusively farmers sell? I suppose that could work, but I assume it would quickly regress into tight relationships like we have (probably regionally variable) for smaller market's, like most vegetables (vs grain) where as I understand it it's largely a direct relationship with the buyer - you probably still sell a future contract, but it's not via a central market and it is 'farm x will deliver to buyer y', i.e. a pre-order if you will, not really a commodity.
And as others say, price discovery, liquidity. What harm does completely open (no obligation) do? And maybe you eat a lot of potatoes and want to lock in the price today. (Or more seriously maybe you're a big baker, but not big enough to be buying direct from farm, your miller is. So grain price affects you, but ypu can't directly control/choose when to take it. Secondary grain futures allow you to hedge risk of it moving against you. In turn this means lower prices or lower risk of shock price increase to your consumers.)
Why didn't the lack of competition result in higher prices before COVID?
I don't know, but it seems like farmers negotiate contracts in advance, so if futures prices are driven up by speculators using easy money then there will be a period of time where farmers are selling for less than they otherwise could because they negotiated futures contracts. Isn't the whole point of the futures market to provide farmers with stable prices, not optimal prices?
So why isn't there a futures market for selling these meats?
The farmer/producer would like certainty of sale, at a certainty of price. This is exactly what a futures option gives them - they can offload the risk of price fluctuations (and demand reduction/changes) in the future, and someone else can speculate on this (and make more profit, or loss).
It seems stupid for a farmer/producer to take on this risk, rather than sell these futures.
Wasn't the original purpose of futures to let farmers and others lock in prices early so they can mitigate risk? Speculation on futures seems dumb if you have no intention of taking delivery.
> Selling crop futures protect you against the price of your crops falling.
Price contracts are a thing. You can do this in new england with fuel oil for heating. It is fairly common.
But futures pay today for a product at some later date. It's a loan as well.
And as a producer it's not just a hedge on price. What happens if your expect to yield 140 bushels of corn an acre, and only get 130? Your crop came in, so no insurance, how do you make up the missing bushels? You're buying those futures back or delivering the contract even at 10x the price.
That isn't an outcome one expects from a hedge or insurance.
There is a reason that there are specialists in marketing and delivery of products with futures markets that help them plan.
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