ZC October 10th DEC19-JUL20 Spread

[gaussian]

I figured I'd make a thread for this to vet my idea. I'm new to trading futures spreads so this gives me a way to learn from some of the people better than me at it here. Please if anything is wrong tell me - I am learning spread trading futures.

First we can look at the term structure of corn:

Despite the horrible planting season, harvest season is off to a good start. The market is currently in contango indicating there is positive carry here. In other words, there is a glut of supply, depressing the front month (DEC 19) and bringing the further dated months (JUL 20 in particular) up. This causes carry to rise because more grain is being forced into silos since it is not needed in the market presently.

Now for the spread:

Pardon the axes. The dates dont make it clear what is where due to how long the data series is. The spread tightened pretty severely in June due to bad crops - naturally because there were a ton of people buying JUL20 corn to offset the probably terrible harvest of DEC20 due to bad weather in June 19.

The September 12th WASDE report:

COARSE GRAINS: This month’s 2019/20 U.S. corn outlook is for reduced production, lower corn used for ethanol, and slightly higher ending stocks. Corn production is forecast at 13.799 billion bushels, down 102 million from last month on a lower yield forecast. Corn supplies are down from last month, as a smaller crop more than offsets larger beginning stocks due to lower estimated exports and corn used for ethanol for 2018/19. Corn used for ethanol for 2019/20 is lowered 25 million bushels. With use falling more than supply, corn ending stocks are up 9 million bushels from last month. The season-average corn price received by producers is unchanged at $3.60 per bushel. This month’s 2019/20 foreign coarse grain outlook is for virtually unchanged production, with fractionally lower trade and stocks relative to last month. Ukraine corn production is lowered, as dry conditions during the month of August reduce yield prospects for filling corn. EU corn production is unchanged, as reductions for France and Germany offset increases for Bulgaria and Romania. Barley production is raised for Russia, Ukraine, the EU, and Kazakhstan, but lowered for Australia and Canada.

Looking back, the spread shrank pretty severely with a steady ramp up from September 10th to now. The market seemed to react negatively to the statement on lower yield, reminding them of the bad harvest before. This is in contrast to the August report that read pretty positively in spite of the year's bad luck.

We are 7 days away from the next WASDE report and the spread seems to have flatlined. I have been unable to find any analyst opinions on the future WASDE reports with many people seemingly worried the crop yield will go down (and rightly so). This leaves two possible trades:

1. The WASDE reports better than expected yield for last month. In this case buying the DEC19-JUL20 is the right move because the increased yield will put pressure on DEC19 and raise the carry on JUL20 as more grain is fed into silos.

2. The WASDE reports flat or low yield. In this case selling the DEC19-JUL20 spread will likely prove profitable. This is because November is the last month of harvest, and a bad yield in October will likely not be great news for DEC. The market will likely bring the Price of JUL down (as grain is withdrawn, reducing carry) and DEC up as supplies of stored corn are purchased.

I'm trading this one fundamentally. I would be interested in hearing any indicators people would be willing to share for monitoring/timing these spreads a little better.

Hopefully this helps someone. I plan on taking a trade on October 10 when the WASDE comes out, and holding it for a around a month - going flat before the next report. If I win something maybe I'll keep it up ;D.

 

[CannonTrading_Ilan]

I figured I'd make a thread for this to vet my idea. I'm new to trading futures spreads so this gives me a way to learn from some of the people better than me at it here. Please if anything is wrong tell me - I am learning spread trading futures.



Hopefully this helps someone. I plan on taking a trade on October 10 when the WASDE comes out, and holding it for a around a month - going flat before the next report. If I win something maybe I'll keep it up ;D.

I asked my colleague Mark O'Brien who trades LOTS of spreads in diff. formats for his input, ( most of us in the office refer and use www.mrci.com when it comes to spreads):

This is a classic “bull spread:” buying a front month and selling a deferred month. In theory, the supply/demand forces affecting corn prices across the board will affect forward month futures contracts to a greater degree because they’re tied to the more immediate commitments of traders: the delivering or taking delivery of the actual physical corn. Thus, higher corn prices would cause front months, i.e., the December ’19 contract, to rise faster than deferred months, i.e. the July ’20 contract.

Adding a little additional fundamental commentary , corn prices typically decline into harvest, with the most extreme pressure normally arriving in early October. Corn and soybeans must compete for storage as harvest activity reaches its peak, but then prices normally stage a relief rally into late October.

 

[gaussian]

Adding a little additional fundamental commentary , corn prices typically decline into harvest, with the most extreme pressure normally arriving in early October. Corn and soybeans must compete for storage as harvest activity reaches its peak, but then prices normally stage a relief rally into late October.

That's pretty interesting and makes sense. Assuming supplies are normal the front month would decline in kind. I assume the rally in late October is the market refusing to let the price fall below a certain "market minimum"?

Right now I am sort of just going off of books (and an old commodity book from 1977). Is MRCI a good resource? Should I consider using it? Why? For corn I've just been watching the various websites from ag schools but I'm definitely interesting in a resource that can at least centralized a little bit of that work for a small fee.

 

[LanceJ]

What is your plan if the spread widens instead of contracting?

 

[CannonTrading_Ilan]

What is your plan if the spread widens instead of contracting?

Need to figure the game plan before entering the trade in my opinion and the answer will vary for diff. traders:
for me personally, figure out max risk and exit based on CLOSING prices - not intraday

 

[CannonTrading_Ilan]

What is your plan if the spread widens instead of contracting?

to expand a bit more.....

Any financial risk you take should include an exit plan for both an unsuccessful as well as a successful outcome. Trading futures and futures spreads is no exception. These can be determined based on a straightforward dollars and cents basis. In the case of futures spread trades – particularly in agricultural markets – seasonal tendencies can be taken into consideration. The general idea is that while lots of factors affect the ups and downs of a given commodity’s price, certain conditions and events recur at annual intervals and give rise to seasonal price behavior – to a greater or lesser degree and in a more or less timely manner. You can think of it as a market's natural rhythm, or an established tendency for prices to move in the same direction at a similar time. Not surprisingly, this can help not only with your exit plan, but with your timing on when to assume the risk of entering the market.

 

[gaussian]

What is your plan if the spread widens instead of contracting?

This is a good question - one I was thinking about today.

I don't think there is any plan for a spread widening with these calendar spreads. If it widens it seems best to get out, since the widening could occur on either leg. If you had the margin you would probably want to adjust the calendar to be weighted more on the side that is gaining. But again, I am no expert on these so maybe someone with more experience (@Cannon_Trading ?) could chime in on my response.

 

[Overnight]

I figured I'd make a thread for this to vet my idea. I'm new to trading futures spreads so this gives me a way to learn from some of the people better than me at it here. Please if anything is wrong tell me - I am learning spread trading futures...

I'm trading this one fundamentally. I would be interested in hearing any indicators people would be willing to share for monitoring/timing these spreads a little better...

This is a job for @bone

Spread-master of ET.