All around the globe, market participants trade basis to the Chicago Board of Trade Soybean futures contract. Basis is the price premium or discount for the physical commodity in a specific location, relative to the futures price. It is driven by local supply and demand, as well as transportation costs between markets.
For the North American region, the basis is referred to as weak when cash prices are low ‒ relative to the US-based, CBOT futures price. This typically occurs when supply of a physical commodity is great, relative to demand at the cash market location.
Conversely, the basis is considered strong when cash prices are high relative to the CBOT futures price. This occurs when supply of a physical commodity is tight relative to demand. This basis relationship is also applicable outside the United States, as basis risk exists around the world for those involved in international trade for commodities such as soybeans.
Brazil is a leading global producer of soybeans with a major export port at Santos. Because exports are a major factor in overall demand, importers and exporters have significant exposure to basis risk in this region. Historically, this basis risk could only be managed through buying or selling the physical commodity.
With the launch of the South American Soybean futures contract, market participants have an additional way to manage basis risk. Utilizing the South American Soybean futures contract, market participants will be able to synthetically trade the basis. This is done by spreading the North American-based Soybean contract - and the price represented by the new South American contract.
The spread, or basis, between the two is defined as the South American contract less the North American contract, converted to cents per bushel. This relationship between the price of the two contracts should reflect where the actual basis stands at any given point in time.
For example, if traders sell the South American Soybean contract and buy the North American Soybean contract, they are synthetically shorting the Brazilian Soybean basis. Conversely, if traders buy the South American Soybean contract and sell the North American Soybean contract, they are synthetically longing the Brazilian Soybean basis.
As an example, let’s assume the South American contract is trading at $374 per metric ton and the North American contract is trading at $9.82 per bushel. Converting the Brazilian price from metric tons to bushels, gives us a value of $10.18. Subtracting the North American Soybean futures price of $9.82 gives us a basis of $0.36 over.
If an importer of Brazilian soybeans is concerned that the basis was going to increase or strengthen, they could buy South American Soybean futures and sell North American Soybean futures ‒ creating a synthetically long basis position. If the spread strengthens, their physical position would lose value, but would be offset with a gain in the spread.
If the spread narrows or weakens, their physical position would improve in value but that gain would be offset with a loss in the spread. Conversely, if a Brazilian exporter is concerned that the basis is going to decrease or weaken, they could sell South American Soybean futures and buy North American Soybean futures ‒ creating a synthetically short basis position. If the spread weakens, their physical position would lose value but would be offset with a gain in the spread.
If the spread widened or strengthened, their physical position would gain in value but that gain would be offset with a loss in the spread. While the Brazilian versus North American basis spread won’t allow a trader to take or make a delivery of Brazilian soybeans, it does allow them to trade the basis without the credit counterparty risk present in the cash market.
Market participants also benefit from the fact that both contracts trade on the Chicago Board of Trade, making the spread easily executable. Additionally, it also reduces transaction costs compared to trading a paper or physical basis market. Whether you are looking to manage regional basis risk or speculate on basis direction, CME Group allows you to do so – all in one marketplace.