AGEC 420: Commodity Futures Markets

Spring 2000
The Soybean Complex
Futures contracts are available for Soybeans (5,000 bu. contract, quoted in $ per bushel) and its
derivative products Soybean Oil (60,000 lb contract, quoted in cents per lb.) and Soybean Meal
(100 ton contract, quoted in $ per ton [2000 lbs]). All of these contracts are traded at the Chicago
Board of Trade. Typically, one bushel (60 lbs) of beans yields 11 lbs of Oil and 48 lbs of Meal.
Soybean processors purchase soybeans and sell soybean oil and soybean meal. The processors
gross revenue can be expressed as follows:
Gross margin

= Revenue - Costs
= Qoil*Poil + Qmeal* Pmeal - Pbeans (where P denotes price and Q denotes quantity)

It is convenient to express gross revenue on a per bushel basis. To do so, we need to do some
conversions since Poil is expressed in cents/lb and Pmeal is expressed in $/ton. Since soybean oil is
quoted in cents per lb., we can simply multiply by 11 to obtain the value of soybean oil obtained
from one bushel of beans. For meal it is a little more complicated since the price is quoted per
ton. To convert tons to lbs., we first divide by 2000 (the number of lbs. in a ton) to obtain the
value of one lb. of meal. Then multiply by 48 to obtain the value of soybean meal obtained from
one bushel of beans. Thus:
Gross margin per bushel

11*Poil + 48/2000* Pmeal - Pbeans

Now lets use some prices to find the gross margin per bushel. Lets say the futures prices are:
Soybeans:
$4.99/bu
quoted on DTN as 4990
Soybean Oil:
19.58 c/lb
quoted on DTN as 1958
Soybean Meal:
$136.10/ton
quoted on DTN as 1361
Using these prices we get:
Oil revenue per bushel of beans
Meal revenue per bushel of beans
Gross margin per bushel

= 11*(19.58)
= 48/2000*(136.10)

$2.15 + $3.27 - $4.99 =

= $2.15/bu
= $3.27/bu

$0.43/bu

Thus the market is offering a gross margin of $0.43 per bushel for processing soybeans. If this is
sufficient to cover the processors costs, then it will be profitable to process soybeans and
sell the oil and meal.
What risk does the processor face? The processors risk is that the margin may narrow either
from an increase in the price of soybeans or a decrease in the price of oil and/or meal.
However, the futures market offers an opportunity to lock in a margin (subject to basis risk which
we will ignore in this example).
The processor can lock in a margin by using a spread hedge (often called a crush spread or
simply a crush). Putting on a crush spread involves the simultaneous purchase of a soybean
futures and the sale of soybean meal and soybean oil futures. Thus, using the numbers above, the
processor would buy Soybean futures @ $4.99, sell Soybean oil futures @ 19.58 and sell
Soybean meal futures at 136.10 (in amounts corresponding to the planned crush).

How many contracts of each commodity are used in the Crush Spread?
Because the amounts of oil and meal that are derived from 5000 bu of beans do not correspond
exactly with the amounts of oil and meal in one contract of each, a 1:1:1 ratio of Bean:Oil:Meal
contracts will not adequately protect the margin.
First, 5000 bushels of soybeans (1 contract) produces 55,000 lbs of oil, which is less than the
amount of oil in an oil contract (60,000 lbs.). Thus selling 1 oil contract for every bean contract
that is purchased means that you will be selling too much oil -- you will effectively be net short
on the oil futures. Thus, a correctly balanced hedge will involve fewer oil contracts than bean
contracts.
Second, 5000 bushels of soybeans (1 contract) produces 240,000 lbs (120 tons) of meal, which is
more than the amount of meal in a meal contract (100 tons). Thus selling 1 meal contract for
every bean contract that is purchased means that you will be selling too little meal -- you will
effectively be net long on meal in the cash market. Thus, a correctly balanced hedge will involve
more meal contracts than bean contracts.
Thus, with a 1:1:1 hedge, the processors margin will fall if oil prices rise or if meal prices fall
because he would be net short on oil futures and net long on cash meal. We saw in class that oil
and meal prices can move in opposite directions in particular an increase in demand for oil will
cause the oil price to rise and the meal price to fall. So, what combination of contracts in the
crush spread will effectively protect the processors margin? To get the optimum combination, we
do the following calculation:
1.

One bean contract produces 55,000 lbs oil, equivalent to 55/60 (or 11/12) of 1 oil
contract.
2.
One bean contract produces 120 tons meal, equivalent to 120/100 (or 12/10) of 1 meal
contract.
3. Thus one bean contract is equivalent to 11/12 of an oil contract + 12/10 of a meal contract
Beans

1
60

=
=

11/12
55

Oil
+
+

Meal
12/10
72

multiply across by 60,

Thus, to perfectly protect the margin the spread should involve buying 60 bean contracts, and
selling 55 oil and 72 meal contracts. In practice, this is approximated in a spread hedge by
buying 10 bean, and selling 9 oil and 12 meal i.e., a 10:9:12 combination instead of a 1:1:1.
Reverse Crush
A reverse crush is essentially a bet that the crush margin will widen. To place the reverse crush,
one takes the exact opposite position to the crush spread ie buy the oil and meal futures and sell
the soybeans.
Exercise:
Setting basis = zero, find the crush margin if futures prices are:
a) beans @ 5230; oil @ 1960; meal @ 1370

b) beans @ 4750; oil @ 1956; meal @ 1352