Managing basis

By Jon Scheve, Superior Feed Ingredients, LLC

After last Monday’s devastating winds across Iowa, there have been a lot of predictions on how many bushels will be lost. However, it will take at least a couple of weeks before the market feels like it knows the full scope. Historically though, actual damages from these types of weather events are often initially overstated.

The market is also evaluating export pace and volume, expected prevent plant acres and inflation. While there are many reasons that corn could rally, it’s important to remember that there are simply too many corn bushels still left in the bins from the last crop.

If prices do rally, export pace and demand would likely be reduced and that could offset lost bushels from the storms. While the USDA did post a 2.75-billion-bushel carryout for the upcoming year, there needs to be a pretty sizable drop to come in below a 2.30-billion-bushel carryout which would still be the largest carryout in over 30 years.

So, while things maybe aren’t as bearish as a week ago, they aren’t likely overly bullish either. In 2016 the USDA published a 2.4 billion carryout in the summer and the market did eventually trade below $3.20 on the December futures. The final carryout that year came in just under 2.3-billion-bushels.

Market Action

Prior to the pandemic, there were strong indications that basis levels would improve going into this spring and summer. Demand was strong and the USDA it seemed had likely over-estimated supply from last year’s harvest. Unfortunately, COVID-19 hit, and my plans needed to be adjusted.

In late May, I set the basis on the first 50% of my 2020 corn production as shown by the Red X in the chart.

Why did you set your basis at that time?

As futures prices stayed low, farmers weren’t selling corn. At the time, multiple out-of-state end users were calling me looking for corn at values above what I could sell locally. Unsure of upcoming basis price direction and expecting that many farmers would likely start selling corn as summer progressed, I thought it was best to set my basis in early May against the July futures. The value I set my basis at turned out to match the best posted price in my area picked up on my farm for the entire marketing year.

Wouldn’t it have been better to set basis in February when basis was higher (represented by the Blue X above)?

The basis values in February look better, but due to market spread, shown by the pink and white chart, it wasn’t. The difference between the March/May and May/July corn spreads needs to be considered because my sales were against July futures, not the March futures.

Comparing apples to apples

I need to account for the spread premiums from March/May at 4 cents (as noted by the pink dotted line) just before the spread went into the delivery period where most traders usually don’t participate. Additionally, the May/July spread eventually traded to 10 cents at the end of April (as noted by the white dotted line) just before it went into the delivery period. So, when I account for the 14-cent spread cost (4 + 10) and subtract it from the -15-basis value against the March futures, the best possible sale in February was the same as selling -29 against the July futures. That means my -22-basis sale against the July futures in May was 7 cents better than the best February basis value available on my farm.

What about the interest in holding your corn from February to May in the bin?

This certainly needs to be considered too. Three months interest on February cash corn values of $3.65 at a 4% interest rate is about 1.25 cent per month or about 4 cents total. This means my sale in May was still 3 cents better than having sold basis against the March futures back in February.

Thoughts on y 2020 basis trade

I thought I was positioned well before the pandemic to get much higher basis than what the market was trading in February. Unfortunately, after the pandemic hit, basis values tumbled. Fortunately, they rebounded some, and I still ultimately traded the best possible level for the year when the carry is factored in. So, I’m pleased with the outcome.

What about the other 50% of your 2020 corn crop?

With the large estimated carryout, the market is paying me, through the spreads, specifically the September ’20 futures to July ’21 futures spread that is currently 38 cents to store grain until next summer. This nearly pays my yearly 30-cent bin payment and 10 cents of interest for holding my corn another 10 month. I arrived at that interest value by taking current cash corn prices in my area that are about $3 right now at 4% interest. While I may not yet be able to pay for all my bin payment at this time it’s very close. Once my bin payment is eventually paid off in a few years, a lot more profit will be going into my pocket every year with this strategy.

What if basis values drop?

I still have a little downside basis risk until next summer, but I’m optimistic basis values will stay relatively consistent. In the last 7 years basis values have traded within 5 cents of the basis value I traded this past spring, and 4 of the 7 years the basis levels trade at or above where I traded my corn basis level this year. While there is always a chance for a black swan event, over time I think I have more profit potential when I expect next year to be a normal year than betting on an outlier year.

Please email jon@superiorfeed.com with any questions or to learn more. 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.

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One comment

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