Capturing market carry

With too much supply in the U.S. and around the world, corn isn’t likely to move in the short-term without a big event.

With 30 to 45 days of the major soybean producing areas of South American growing season left, there is still a lot of weather premium potential left in beans right now.

 

Capturing market carry

After Dec options expired on 11/24/17, it left me short several Dec future contract positions. Since Dec futures go off the Board of Trade soon, I have to move them to a future contract month. I want to make sure I maximize my market carry opportunities with these trades, but also consider practicalities, like when I will have to core my bins centers out. I selected March ’18 futures.

Unfortunately many farmers don’t take full advantage of market carry. This is a shame, because it’s a relatively easy, low risk way to add profit to a farm operation. For me, market carry pays for my on-farm grain bins and then some. Following provides detail on how I will collect market carry on these recent trades and answers some questions farmers have on collecting carry.

 

Trade 1 — Capturing the carry (Dec to March)

When capturing market carry, I have to keep my position unchanged. In this case, I bought back the short Dec futures on 11/29/17, and sold the March futures at the exact same time, capturing the 14.5-cent spread. On a monthly break down this is 4.83 cents per month because Dec to March is a three-month trade move (14.5 / 3 months)

Does it matter what futures are when this is done? No. This can trip up some farmers, but the only thing that matters is the spread. With March futures higher than Dec by 14.5 cents market carry, I buy the Dec futures back and sell March futures, I’m left with only the profit of the spread. This follows business rule #1, Buy Low/Sell High. In the end, my hedge is still in place and I capture the profits of the spread which is market carry.

 

Trade 2 — Old Crop market carry

I also moved my futures position for some 2016 corn I have stored and priced and will hold until 2018. Those hedges were in the Dec ’17 futures too, so I moved them to Mar ’18 as well and collected 14.5 cents on that trade as well.

Why choose Mar ’18 versus another future month? There are several things to consider when selecting your carry month.

 

Historical spread trends

Many would choose a summer month like July. However, when I analyzed the average monthly spread premium from Dec to July, a 7 month spread, it is currently paying 30 cents carry. To me this isn’t big enough. Because, over nearly the last year corn has paid nearly 5 cents per month when rolling one futures contract forward each time. This is likely a result of massive amounts of corn in storage in the US and around the world. In other words, the past year historicals indicates the spread between Dec and July should be closer to 35 cents.

 

Commissions

While I want to maximize carry, it’s important to consider commissions too. Each time I move futures forward I pay one cent. So if I moved futures from March to May and then May to July, I could end up paying 3 cents extra in commissions to try and capture 5 cents of extra premium. That extra 2 cents of potential probably wouldn’t be worth the risk so it comes down to when I think I will actually move this corn.

 

When I need to move corn

Right now I’m not sure when I’ll be physically moving some or all of my corn, it could be winter, spring, or summer. If I move futures to July but then have to move some back to March or May because I end up physically moving some of my grain, I could lose one cent of commission.

Unfortunately, much of my 2017 crop is still not fully priced. One cannot capture carry if they don’t have the crop sold. Thus I’m missing some opportunity. As time marches on, market carry opportunity decreases, so that always needs to be considered. If I had more of my crop sold, I may have consider a percentage against July futures at a 30-cent spread to reduce some risk.

 

Letting options expire versus buying them back

I recently mentioned how I let most of my options expire or get exercised. Several farmers said they didn’t know farmers could do that and wondered why I would want to do this.

Usually, I let many of my options get exercised or expire worthless. Buying options back that have been sold previously costs half- to 1-cent in market premium and another 1half-cent in brokerage fees. Adding these additional premiums and fees to all of my trades erodes my profitability. For example, had I bought back all of the options discussed in last week’s commentary where I had seven trades in place actually involved about 20 different options. That means on 100,000 bushels the extra fees would have been close to $1,500. Since I was comfortable with any trade scenario happening, the extra fees and commission seemed like a waste.

 

But what if my broker doesn’t charge for taking an option position off?

If that’s the case, I would ask what the broker charged to put the position on in the first place. In my experience, if there is no cost by a broker to take an open position off, then the broker is already charging the farmer “round trip prices” upfront. I would recommend that a farmer negotiates with their broker to only charge half upfront and half on the backend, so that a farmer is only paying for what they need. A good rule of thumb for me is to minimize the number of trades in my hedge account to reduce lost premium as well as commission fees whenever possible. Lots of trading doesn’t always mean more profits.

 

Why not try to get out of some trades at different times?

I’m not very good at trying to time the market. When I’ve tried in the past, I’m usually disappointed in the results. However, when I make a plan and stick to it, my outcomes are much better. Since I have trades built around a number of possible outcomes on each trade, if I am patient and let the trades develop, I’m generally happy in the end.

I’m not alone though. No one is an expert at timing the market on a consistent basis, despite the confidence of “experts” in trade. Those that have had some perceived success can become overly confident that they know something no one else does. In reality, these people may have just been lucky.

I prefer to stick with my marketing plan that was developed and put in place long ago. I have no idea where the market will go, but my plan was designed for any market direction I might face. I continue to have trades in place for any possible market scenario going forward. I don’t like to try and guess what will happen next, because what if I’m wrong?

 

Jon grew up raising corn and soybeans on a farm near Beatrice, NE. Upon graduation from The University of Nebraska in Lincoln, he became a grain merchandiser and has been trading corn, soybeans and other grains for the last 18 years, building relationships with end-users in the process. After successfully marketing his father’s grain and getting his MBA, 10 years ago he started helping farmer clients market their grain based upon his principals of farmer education, reducing risk, understanding storage potential and using basis strategy to maximize individual farm operation profits. A big believer in farmer education of futures trading, Jon writes a weekly commentary to farmers interested in learning more and growing their farm operations.

Trading of futures, options, swaps and other derivatives is risky and is not suitable for all persons. All of these investment products are leveraged, and you can lose more than your initial deposit. Each investment product is offered only to and from jurisdictions where solicitation and sale are lawful, and in accordance with applicable laws and regulations in such jurisdiction. The information provided here should not be relied upon as a substitute for independent research before making your investment decisions. Superior Feed Ingredients, LLC is merely providing this information for your general information and the information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision. The contents of this communication and any attachments are for informational purposes only and under no circumstances should they be construed as an offer to buy or sell, or a solicitation to buy or sell any future, option, swap or other derivative. The sources for the information and any opinions in this communication are believed to be reliable, but Superior Feed Ingredients, LLC does not warrant or guarantee the accuracy of such information or opinions. Superior Feed Ingredients, LLC and its principals and employees may take positions different from any positions described in this communication. Past results are not necessarily indicative of future results. He can be contacted at jon@superiorfeed.com.

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