Futures Spread Risk in Soybean Hedge-to-Arrive Contracts

In the 1995/96 crop year, record high corn futures prices and inverted spreads eroded the cash flows and financial capabilities of both farmer hedgers and elevators who implemented the rollover provisions in hedge-to-arrive (HTA) contracts. Participants in the 1995/96 corn market who used the exotic HTA multiple-year mechanism faced large unexpected margin calls and/or sharply lower "net" prices than expected, as the July-December old crop-new crop inverted corn spread widened to very large negative levels. We evaluate the soybean futures spreads in the 1948-1997 period, and the associated monetary risks inherent in the rollover provisions of the HTA contracts. In the 50 years in which current soybean May, July, and November contracts have been trading, the probability of old crop-new crop spreads being in the plus/minus 10 percent range of the old crop "normal" price was approximately 75 percent and the probability of having negative spreads exceeding 10 percent was only 20 to 25 percent. However, the high-price years (over 20 percent above normal old crop price) had a 100 percent probability of having a negative spread and a 50 to 60 percent probability of having a negative spread exceeding 10 percent. Merchandisers offering HTA contracts should be aware of these risks and communicate them to farmers considering their HTA contracts.