I don't quite understand how the pricing for wheat futures works. Supposedly, for Chicago SRW, the contract is for 5000 bushels. So a call would allow me to buy 5000 bushels, but at what price? What is the strike price?

When I look at the quotes for SRW it says that the July '18 contract is currently trading at about $520. So, what exactly does this mean? I know that wheat typically sells for around $5 per bushel, so 5000 bushels would be about $25,000 or so. So, I can buy $25,000 in wheat for $520 ??? That makes no sense.

Also, where is the price for bushel? All the quoting sites I can find simply list the future contract prices, they don't seem to list the actual price for the wheat itself. Where do I find that?

  • Where does your spot price of around $5 per bushel come from? The spot wheat price on every website I look at is about 530 currently... (xtb.com/en/trading-services/range-of-markets/… for example)
    – MD-Tech
    Jun 7 '18 at 10:45
  • Where does your 5000 figure come from? Speculation: elsewhere on PF&M, futures/calls/options contracts for shares seem to normally be for 100 of the underlying... at ~$5/bushel, that would fit with $520 if the contract was for 100 bushels.
    – TripeHound
    Jun 7 '18 at 10:45
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    @TripeHound I think we've found the same issue with OP's maths from opposite sides!
    – MD-Tech
    Jun 7 '18 at 10:49
  • @MD-Tech Those prices in your link are contract prices, not prices per bushel. A bushel of wheat weighs 60 pounds and sells for around $5 to $10. Jun 7 '18 at 10:53
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    I'm an idiot - the price for the futures is in cents not dollars which is the discrepancy! see: cmegroup.com/trading/agricultural/grain-and-oilseed/…
    – MD-Tech
    Jun 7 '18 at 11:02

The price of 520 on the website that you have given is in cents not dollars - see http://www.cmegroup.com/trading/agricultural/grain-and-oilseed/wheat_contract_specifications.html. Dividing by 100 gets us $5.20 for the price of a bushel. 5000 * 5.2 is 26,000 which is comparable to what you thought it should be.

The price for a future is the price for delivery of the contract at the time in the future and is made up of three parts; the current wheat price, the risk free interest rate (or a proxy for it) and the cost of carry. Except where there are special economic reasons for it (see backwardation for details) you would expect the price of a commodity for delivery in the future to be greater than the cost to buy it now (this is called contango) since if the price were lower in the future then it would be better to buy the commodity in the future than to buy it and store it. Since it would be better to buy it in the future in that case people who want the commodity for delivery would buy up the futures contracts instead of buying at spot and storing the commodity driving the price in the future up. This leads to an upwards curving futures curve.

The risk free rate of interest is important as a pricing mechanism because it prevents the arbitrage opportunity of selling the spot short now at a higher price (say $10), using the money that has been gained from the short sale to buy a futures contract at a lower price(say $5). At delivery I will be able to buy the $10 worth of wheat that I sold short for $5 and make $5 free profit. The value of the $5 free profit must be discounted using the risk free rate to get the value at the current time. This means that the futures price must be at the minimum the current price plus the cost of carriage discounted using the risk free rate from the futures date to the current time so that I can't get a free lunch. This violates the no-arbitrage principle, the numbers are massively out on reality for didactic purposes.

The current price of the commodity is obviously used in all of the calculations above.

In scarce commodities the expected future production of the commodity plays a larger role.

  • This does not answer the question. First of all, you do not explain where the current price comes from, nor do you explain what the strike price is for the contract, if there is one. If the price for the contract is $5.20 per bushel, then it would be ~$25,000 for the contract, but that would be too much money, because the wheat itself would only sell for about $25,000, so nobody will spend $25,000 for a contract on $25,000 worth of wheat. I would expect the price of the contract to be significantly less than the total value of the underlying commodity. Jun 7 '18 at 11:11
  • @FiveBagger A futures contract is not an option contact. You are contracting to buy the commodity, but at a future date for delivery. If you would pay less to establish and maintain the contract in the meanwhile, you are referring to margin financing. See "margin" at investopedia.com/university/futures/futures4.asp. Jun 7 '18 at 11:18
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    @FiveBagger it appeared from your question that you wanted to know why the prices looked 100 times too high, which is because they are priced in cents. You did not make it clear that you didn't understand contango.
    – MD-Tech
    Jun 7 '18 at 12:31

MD gave a correct answer, but I see it doesn't address some of your comments:

Where does the price come from?

Similar to stocks, it comes from other market participants (bids and asks). MD is correct that technically it is based on the the future value of the current "spot" price plus carry costs, but in reality it is set by whoever is willing to trade futures with you.

Why would I spend $25,000 for a contract on $25,000 worth of wheat

Suppose you are a bread maker, and you know in 6 months that you are going to need 5,000 bushels of wheat to make your bread, and have no way to store the wheat today. You don't know what the spot price of wheat will be in 6 months, but today the spot price is $5 per bushel, and the 6-month future is quoted at $5.05. You are willing to pay $5.05 in 6 months, but don't want to take the risk that the price goes up to, say, $5.50. So you sign a contract today to pay $5.05 per bushel for 5,000 bushels of wheat in 6 months (you pay nothing today, but will pay $25,250 when the contract settles in 6 months). Yes, you might miss out on a price drop, but you're willing to give up that possibility in exchange for removing any risk of the price increasing.

  • You are not understanding me. The price I am talking about is the spot price of a bushel of wheat, not the future contract price. The linked page only lists the price for a contract, not the underlying commodity. Jun 7 '18 at 14:40

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