What Spreads Can Do for You and How to Use Them
This time of year (winter), generally speaking, old crop prices move more than new crop prices. Old crop prices are sensitive to current events and Southern Hemisphere S&D factors, whereas the new crop availability is so far in the future with so many production and demand variables, that news in December to mid-March impacts new crop prices very little compared to old crop. Thus, on down days, old crop will lose more than new crop prices and on up days, old crop prices will gain more than new crop.
We currently (winter 2021) have an unusual situation with old crop corn, soft red winter wheat, and soybean prices because old crop prices are a premium to new crop prices. Such a condition is called an inverted market. What is even more unusual this year is the magnitude of inversion for corn and beans. Note that spring wheat (traded at the Minneapolis Grain Exchange) and hard red winter wheat (traded in Kansas City) have new crop prices above old crop prices, which is the normal market situation.
New crop prices are usually higher than old crop prices because the old crop is safe and sound in the bin, but the new crop has yet to be grown. The market knows there is weather (and political) risk which may keep the new crop production total from meeting the full demand. This is usually referred to as the “weather risk” factor
Crop year prices will invert when the market is more concerned about short supplies of old crop than it is concerned about short supplies of new crop. This concern for old crop supplies can be caused by a poor crop the previous summer or unexpected strong demand into the winter or both.
When one is confident the market is going to move higher for a period of time, he should buy a nearby month and sell a deferred month as the market removes carry from the market to encourage cash sales.
When one thinks the market is going to move lower for a period of time, he should sell an old crop month and buy a deferred month as the market will build carry into the market to encourage farmers and elevators to store excess bushels.
Spread trades must be done in a futures account because it is not practical to buy and sell physical bushels of old crop grain and impossible to buy or sell physical new crop bushels in the winter because it has not been harvested yet.
The process to establish a spread position is decidedly different than the process to establish a normal long or short futures position. This is exactly what to tell your broker for a down market:
Spread order, sell one July soybean, buy one November soybean at a $2.02 premium to the July sell.
The $2.02 is an example spread price; the price difference should be whatever you think can reasonably be filled.
For an up market, the order would be:
Spread order, buy one July soybean, sell one November soybean at a $1.72 premium to the July sell.
Note: when placing a spread order, state the nearby month first. When discussing spreads, always state the long side first.
If someone tells you he has a corn/wheat spread, that means he is long corn and short wheat because he said “corn” before he said “wheat”.
If someone says he has a new crop/old crop corn spread, he has bought a new crop month of corn and sold an old crop month of corn.
If someone says he has a bull corn spread, that means he bought a nearby month and sold a deferred month, but not necessarily old crop and new crop. It could be a March/May or a May/July or a July/December or a December/March spread even though that is nearly a year out.
A bear wheat spread is when a person bought a deferred month contract of wheat and sold a nearby old crop month of wheat, but not necessarily new crop and old crop.
It is advisable to make your spread orders open (aka, good till cancelled) because it is much more difficult to fill a spread order than a straight buy or sell order. A spread order takes three traders, you, a buyer and a seller. A straight sell (or buy) order takes two traders, you and a buyer (seller).
For those of you trading with a digital platform on your smart phone or computer, you can place spread orders, but you probably need some instructions on how to do that. The procedure is not difficult to do, just different than a buy or sell order.
The margin requirement for old crop/new crop spreads is about 50% of a net long or net short futures position. For same crop year spreads, the margin requirement is about 20% of the margin for a net long or short futures position. Check with your broker.
In the past four weeks, the November/July soybean spread has ranged from $1.68 to $2.11. The December/March corn spread has ranged from 87 cents to $1.11.
Hint: the seasonal trend on corn is up until the third week in June and the seasonal trend on wheat is down until late summer. And the seasonal trend will be that way every year for the rest of your life. But nothing is 100% in this business; if it was we all would be rich.