What it means
A cash contract is negotiated privately between the two parties, so almost everything in it is open to agreement: the exact grade, the quantity, the delivery point and the timing. That flexibility is the whole reason physical businesses use it rather than an exchange contract.
It matters because this is where the real commercial transaction happens. Futures markets set the reference price, but a cargo of grain is actually bought and sold under a cash contract, at a price usually expressed as the futures price plus or minus a local adjustment called the basis.
The basis reflects everything local: transport to the delivery point, storage availability, local supply and demand, and the quality of the specific lot. A buyer who hedges with futures still carries basis risk, because the futures position protects against the reference price moving but not against the local adjustment changing.
The main hazard is that no exchange stands in the middle. If the counterparty fails to deliver or fails to pay there is no clearing house to make good the loss, so credit checks, deposits, letters of credit and performance bonds do the work that margin does on an exchange.
A cash contract for delivery some weeks or months ahead is often called a forward cash contract, and it is still a private agreement rather than an exchange instrument. The practical difference from a futures contract is that someone genuinely expects the goods to turn up.
In practice
Real-world examples.
Example
A grain grower signs a cash contract in August to deliver 20,000 bushels to a local elevator in November, priced at the November futures price less 25 cents. She knows her delivery point and her quality are settled, and only the futures leg of the price remains to be fixed.
Example
A copper fabricator buys physical metal on a cash contract from a merchant and separately sells futures to protect against a fall in the metal price while the stock sits in its yard. The physical purchase and the futures sale do different jobs, and the firm's accounts keep them separate.
Example
A coffee roaster takes a cash contract for 15 tonnes of one specific single-origin lot, something no exchange contract could provide because exchange grades are deliberately generic. The roaster accepts the counterparty risk because the quality of that particular lot is the entire point of the purchase.
Formula
Calculation
Cash price = nearby futures price + basis
A flour miller agrees a cash contract for 10,000 bushels of wheat with a local grower. Nearby wheat futures are quoted at $6.20 a bushel and the local basis is 30 cents under futures, so the cash price is 6.20 - 0.30 = $5.90 a bushel and the contract is worth 10,000 x 5.90 = $59,000. If the basis later narrows to 10 cents under futures while the futures price is unchanged, an equivalent cash contract would price at 6.20 - 0.10 = $6.10 a bushel, or 10,000 x 6.10 = $61,000. The 61,000 - 59,000 = $2,000 difference comes entirely from the basis, which is why even a hedged buyer watches it closely.Case study
Seen in the real world.
Marlowe Feeds is an illustrative, fictional animal feed producer that bought maize entirely on the spot market, taking whatever price the day offered. A poor season pushed prices up 30% in four months and the business had no cover at all.
The new commercial manager moved to forward cash contracts covering roughly 60% of expected usage, each priced as the relevant futures month plus an agreed basis, with the balance still bought on the day. He also split the volume across three suppliers and took trade references on each, because a cash contract has no clearing house standing behind it.
The following year prices fell, and the illustrative outcome was that Marlowe paid slightly more than the spot market for its contracted volume. The board accepted that, because the purpose of the contracts had been to make the cost of feed predictable enough to quote firm prices to customers, not to beat the market.
Watch out
Common mistakes.
- Using cash contract and futures contract as if they were two ways of doing the same job, when one is a private deal for actual goods and the other is a standardised exchange instrument used mainly for price risk.
- Assuming a futures hedge removes all price risk on a cash contract, when the basis can move independently and leave the hedge incomplete.
- Skipping counterparty checks because the deal looks like a market transaction, when there is no clearing house to cover a default.
Questions
People also ask.
Is a cash contract the same as a spot contract?
A spot contract is the immediate version of a cash contract, while the broader term also covers forward cash contracts for delivery weeks or months ahead.
How is the price in a cash contract usually set?
Most often as a named futures month plus or minus an agreed basis, which lets both sides separate the national price from local conditions.
Do cash contracts require margin payments?
Not as a rule, because they are private agreements, although sellers often ask for a deposit, a letter of credit or a performance bond where the counterparty is unfamiliar.
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