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Examples of how yoq

by Ronold J. Frost Vice President, Chicogo Mercontile Exchonge

always takes a position in the futures market that is opposite to his cash position, that is, what he owns.

For A Producer

Let us say, for exdmple, that in January a producer has a supply of logs in "cold deck." Based on his experience, he real-

Slory di o Glqnce

Three commodity markets now provide futures contracts for lumber and plywood The Chicago Mercantile Exchange, New York Mercantile Exchange and the Chicago Board of Trade. While mastery of the devilishly complex futures business would likely take a lifetime, a (relatively) simple outline is presented here.

\zes that these logs will be ready for sale in April and he needs $I00 MBF to break even. After checking private and government reports, the producer expects a severe market decline. He then checks the futures market for April and finds April lumber futures at $lI0 MBF. He would then sell enough April futures to cover his log inventory.

Now, what happens in April? Let us say, for example again, tlat the cash maiket has deteriorated to $75 MBF. Because futures generally move proportionately with the cash market, the futures also would have declined, let's say, to $76 MBF. He would therefore have lost $25 MBF on the cash market but would have made $34 MBF on his futures contract when he bought it back in April for a net profit of $9 MBF.

If the cash market had gone the other way, the producer's cash gain would be offset by a loss in the futures market. But, he hedged in the first place because of market uncertainties and he wanted to protect the price he'd receive for his lumber.

Also, a lumber company, when purchasing lumber rights to national {orests, can use the futures market to hedge its stumpage bids. Lumber producers will be able to look forward to lumber futures prices months in advance for another guide to bidding for stumpage.

However, the following adjustment must be made to adjust a Chicago futures quote to a oolocalized West Coast quote." Shipping on a 2,200 lb. basis from the Northwest amounts to $31.25 per contract to Chicago. Brokerage on 36,000 board feet basis amounts to $I.00. Let us assume margin costs at 9/o' on $400 x 6 months equals $9.00 or 50{ per thousand board feet. These costs totaling $32.75 must be subtracted from the Chicago futures to get a true West Coast price level of $77.75 in the above example.

For A Whotesater

Since a transit-wholesaler often orders lumber and has it rolling before he has a buyer, he incurs a price risk. Also, he is faced with the possibility, in some cases, with having to pay the high cost of demurrage, Because ''lqmber, prices can fluctuate as much as $20 MBF'in a week, it would be to his advantage to at'least consider the futures prices in the nearest month to protect himself against a price decline.

A distributor will be able to use the Iutures market in two ways. (I ) When futures prices appear low enough he can buy futures and virtually assure himself of a supply of lumber at what he concludes are favorable prices. This would be a buying hedge. (2) When a distributor acquires an inventory, he would simultaneously sell a futures contract. This would give him a fixed value of his inventory and protect him against adverse price movements. This would be a selling hedge.

RETAILER-HOME BUII.DER

Builders taking bids from subcontractors on a guaranteed basis generally find these bids higher than bids received on a non-guaranteed basis. Of course, with the cheaper bid, the builder incurs the risk of price fluctuations. However, with the advent of futures. the builder can ofiset this risk with a hedge.

Here is an example of one housing producer who faced the choice of sirb-contracting the framing of two tracts of houses at guaranteed lumber prices or at nonguarartteed lumber prices. The bids from

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