Basis trading

By Jon Scheve, Superior Feed Ingredients, LLC

Recession fears continue to plague the market, preventing any major buying by the funds. While weather forecasts are changing daily, the latest USDA national yield estimate of 177 could still be achieved. However, if widespread extreme heat continues with little rainfall over the next two weeks, the national yield average may decrease by 1 or 2 bushels, which would likely mean upside potential in the corn market.

Last week I explained how I rolled my July sold futures positions to the May contract and collected 48 cents. This was made with a basis trade at the same time. Following provides some historical context on why I made the basis trade and the final outcome.

During the first few weeks of the Ukraine war the market was very nervous. Traders and risk managers started making trades that covered their needs, anticipating worst case scenarios.

Initially, there was a lot of panic and fear, so the market went into “buy everything” mode. Wheat was the first commodity to really take off. End users began moving their bids against the May contract to the July, September, or even the December contracts for immediate shipment, because the May contract was climbing much faster than later months. This meant cash values were not climbing as fast as futures. No one knew what would happen next because sellers were unsure if they should continue to hold grain or sell immediately and, buyers wondered how they should hedge the grain they were purchasing. There was concern this uncertainty would carry over into the corn market too.

Seven trading days after the war started May corn futures went from $6.80 to $7.80. From Feb. 28 to March 3, corn futures spreads between the May and July contracts widened from a 12-cent inverse (i.e., May was 12 cents higher than the July contract) to a 50-cent inverse.

Early on the morning of March 3, I noticed grain buyers in the eastern Corn Belt moved their basis bids to the July contract. I figured it was only a matter of hours before western Corn Belt grain buyers did the same. 

Therefore, I set my basis with one end user for the best delivery time value they had posted. That ended up being the April/May shipment period against the May futures. This shipment time period was higher than the March shipment period shown in the chart below by the yellow X. I made the trade on 70% of my 2021 corn production. 

The chart above shows the posted March shipment period bids, with freight rates from my farm subtracted from the price, from several nearby end users. When all freight rates were considered, several buyers were basically bidding the same price to me. The basis at my local end users did drop at the close of trading on March 3 and as seen by the chart above and continued to drop over the next 2 weeks by another 30 cents.

Since this basis trade was set against May futures, all my hedges in the July futures contract needed to be rolled back to the May contract. This enabled me to also capture additional profit on the huge market inverse of 48 cents represented by the green arrows in the chart above.

This meant the basis value I sold for corn picked up on my farm for -10 on May futures was like trading +38 on the July futures picked up on my farm. This type of level would equate to the best basis value I have EVER sold, or even seen available to me for my farm, including the drought crop years of 2011 and 2012.

I could have chosen to not set basis and just rolled the July contract back to the May futures and hoped the spread would eventually collapse and then look to roll the spreads again back to the July and set basis in June. However, many in the trade told me they expected the spread to go to levels substantially higher than where it was trading much like the year before (see in the first chart). I was concerned the basis would drop more than any gain I may get from trading the spread. That’s why I wanted to minimize my risk by moving any grain with futures sales against it, at values that I knew at the time were the best ever.

Another 10% of my production also had a futures price objective hit against the May contract right after the invasion. I set the basis on those bushels at the same time but was not able to capture the spread trade premium since those sales were not ever in the July contract.

This basis trade cleaned up the ’21 crop short positions in my hedge account and left me with 20% of my production unpriced on both futures and basis. At the time I was unsure what to expect from the markets with the first war in Europe in over 80 years. I felt the best risk management plan was to avoid guessing what the spreads, basis or futures were going to do from that point forward during a time of war. I moved to the sideline and waited for more information.

Next week I will share what I did with the last 20% of my grain in the bin.

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.