Estimated Protection to Shorts on Old Contracts Closed Out June 13

Based on the average of spot price quotations in Chicago for the months of July, August, and September, insofar as such quotations are available, Table 10 persents an estimate of the probable increase in value of quantities of wheat, corn, rye, and barley contracts for those months that were closed out on June 13.

TABLE 10. PROBABLE INCREASE IN VALUE OF JULY, AUGUST AND SEPTEMBER WHEAT, CORN, RYE AND
BARLEY CONTRACTS CLOSED OUT ON JUNE 13 HAD TRADING BEEN CONTINUED TO THE TERMINAL
MONTHS

With the expiration of price controls on July 1, 1946, the cash price of contract or better grade of wheat moved sharply up as shown in Chart I from the level of $1.97 per bushel prevailing under government controls to $2.18 on July 2, and reached its maximum of $2.15 on July 11. Thereafter its price sagged to only slightly above the June ceiling during latter part of the month, and finally leveled off at about $2.02 for most of August. During September, prices were scattered and fluctuating with an upward trend to $2.10 1/2 on September 27, and $2.11 on September 30.

There was no trading whatever in wheat futures on the Chicago Exchange until August 26, when trading was opened on January, March, and May 1947 futures only. These three futures closed on dates approximately 5 days apart from August 26 to September 30 at the following prices:

Since there was no trading in July, August or September wheat, it is impossible to know whether trading in these futures would have influenced the cash price. The general indication, however, would seem to be that with a bumper crop of wheat ready for market, the trade discounted the future, and the exorbitant prices feared by frightened shorts and expressed by the Chicago Board of Trade in Regulation 1899 failed to develop in cash trading, and might not have developed had there been trading in futures for these two months.

Nevertheless, the saving to shorts by closing out July, August and Septembe contracts on June 13, was appreciable. Assuming that shorts would have lost a least the difference between the price at which their positions were closed out on June 13 and the average of published spot prices for contract grade wheat in each of the terminal months, the saving to shorts (and the loss to longs) through the June 13 close-out of 10,892,000 bushels of July, August and September wheat contracts would probably have been of the order of $777,128 as shown in Table 10. This would represent a saving to shorts and corresponding loss of potential profit to longs of 7.1 cents per bushel.

Corn

For corn, the showing is quite different from that for wheat. Here, the spot price for contract grade rose more sharply from $1.44 (nominal) on June 30 to $2.15 on July 1, and to its maximum of $2.28 on July 16, and averaged $2.183 per bushel for the month. Thereafter cash corn sagged in price and averaged $1.905 for September.

As shown in Table 10, the probable saving to shorts (and loss to longs) from prematurely closing out 7,276,000 bushels of July and September corn futures contracts would have been of the order of $4,190,564. This amount would represent an average saving to shorts of 57.6 cents per bushel of contracts closed out.

For corn, the supply was very short, with no appreciable quantity of new crop available for some time after September 30. High prices brought out corn previously not visible in July and August. Under these circumstances, continued trading would have occasioned shorts very heavy losses. On the other hand, closing out the futures prematurely caused correspondingly heavy potential losses to longs. Protection of shorts wholly nullified the insurance value of all long hedges. The losses that some long hedgers were obliged to take under their firm forward cash commitments were large. In some instances special arrangements were made between grain merchants who were so hedged and their cash customers whereby the increase in price was divided between them on some agreed upon basis.

In addition, the fact that no adequate hedging protection was available to grain merchants caused them to be reluctant to buy and stock corn on any basis. Buying and selling cash corn became buying only against firm orders in hand. One grain merchant interviewed, who had been able to make an adjustment of the type described above with a large cash customer, stated in August that without adequate hedging protection, he was buying corn only to fill commitments and was bidding in the country on a basis to yield him merchandising margins much larger than usual, even on corn for which he had firm orders. He stated that he would buy no cash corn for storage on his own account except on such a basis as he considered might yield him 15 to 20 cents per bushel whereas, with hedging protection, he would be willing to handle grain on a margin of 3 to 6 cents per bushel. This meant that, in general, he was offering the farmer from 14 to 17 cents per bushel less than he might otherwise have done.

Similar procedure was stated to be true to only a less extent for other grains for which many country elevators either likewise bid low prices, or accepted the farmer's grain for storage subject to pricing when sold. Thus, without hedging protection, grain merchants widened their margins at the expense of the farmer in order to cover their uninsured risk as merchants, or shifted the risk of possible price recession entirely to the farmer until such time as his grain was actually sold in the uncertain and fluctuating market.

Rye

July and September rye contracts represented the third largest quantity of contracts prematurely liquidated on June 13. There was no trading in any rye future in Chicago after June 13. Here, the supply was abnormally short and little cash rye went through public cash market channels in Chicago during the months of July, August and September. There were, in fact, no cash market quotations in July, only 3 in August, and 1 in September. The average for the 3 August quotations was $2.01 per bushel, and the single quotation for September was $2.35.

Assuming that the July rye future could not have been closed out at less than the average of $2.01 for the 3 quotations in August, and that September contracts were closed out at $2.35, an extremely conservative estimate of the gain to shorts (and loss to longs) resulting from premature closing out of July and September rye contracts would have been of the order of $2,468,910, or an average of 55.9 cents per bushel on the 4,418,000 bushels closed out. This estimate is based on an assumed increase of 42 1/2 cents per bushel for the July future and 76 1/2 cents per bushel for the September future as shown in Table 10.

Another estimate of the possible protection to shorts might be based on the price of rye futures in Winnipeg, where it is understood there was no price control over the future. It also appears that the price of Winnipeg futures contemplates delivery at Fort William or Port Arthur from which points Lake - rail rates for shipment to eastern points do not vary greatly from those on shipments from Chicago. Therefore, the Winnipeg price would appear to represent fairly well the world price for rye either at Canadian shipping points or at Chicago.

As shown in Table 8 the average price of the July future in Winnipeg during July was $2.943 per bushel, while the average for the October future, which most nearly corresponds to Chicago's September contract, was $2.023 for the month of August and $2.257 for September. With the exchange rate for free Canadian dollars at 96, which prevailed during much of July and throughout August and September, these Canadian prices would be equivalent roughly to $2.825 per bushel for July, and $2.167 for September. Based on these equivalents in U. S. dollars, the possible savings to shorts would be of that order of $4,334,058 computed as follows:

On this basis, the average saving to shorts, and loss of potential profit to longs, resulting from the June 13 close-out was of the order of $.981 per bushel as compared with $.559 based on the few cash sales made in Chicago. The actual financial effect possibly lies somewhere between these two extremes. On either basis the saving to shorts, and the loss of potential profit to longs, was large.

Barley

Barley is relatively unimportant in volume of futures trading. Only 426,000 bushels of July and September contracts were closed out on June 13.

Two series of cash quotations for the Chicago market are, respectively, for feed and malting barley of No. 2 or better grade. There were no official quotations for either during July, 10 for both in August, and only two, both for feed barley, in September. All other prices quoted were "nominal." Since the prices for the two qualities did not differ greatly they have been combined into one series and averaged in Table 9.

If it is assumed that the July futures could not have been closed out at less than the average of $1.704 per bushel for official cash sales in August, and that September futures might have been closed out at the officially quoted cash price of $1.63 in September, the saving to shorts (and loss to longs) on 426,000 bushels of barley contracts closed out prematurely on June 13 would be of the order of $132,690, as shown in Table 10. This would amount, on the average, to about 31 cents per bushel.

Total July, August and September Contracts

A total of 23,012,000 bushels of July, August and September wheat, corn, rye and barley futures were closed out prematurely on June 13. Recognizing that it is impossible to estimate with accuracy the benefits to shorts, and loss to longs, through these close-outs, a conservative estimate based on the record of official cash prices for these grains in Chicago, would be, as shown in Table 10, that the total involved would have been of the order of $7,569,292. This total does not take into consideration any futures for months subsequent to September 1946, for which no cash price history is yet available.

If however, the benefit to shorts is computed for rye on the basis of Winnipeg futures, the total would be of the order of $9,434,440.

Using the more conservative total of $7,569,292, and adding this amount to the total saving to shorts of $2,914,330 arising out of premature closing out and liquidation of futures at old ceilings prior to May 31 as shown in Table 5, yields a total estimated protection to shorts arising out of actions of the Board of Trade of the order of $10,483,622.

If, however, the estimate for rye based on Winnipeg futures is used, the total estimated protection to shorts becomes of the order of $12,348,330.

Over against these estimated total savings to shorts it is to be noted that by settling defaulted May futures at ceiling, and by trading out and finally settling old futures (other than oats) at ceilings through June 13, shorts assumed actual financial responsibility for ceiling price increases to the extent of $6,815,450. (See Table 5.) Taking this assumption of responsibility into consideration, the statement of net benefit to shorts, including estimates for price increases after July 1 on July, August and September contracts settled on June 13, may be stated as follows: