Carry vs. inverse

By Jon Scheve, Superior Feed Ingredients, LLC

In recent weeks, the U.S. dollar has moved to its highest value in 20 years because of worldwide recession concerns and the belief the U.S. economy will likely weather the storm the best moving forward.

A strong U.S. dollar makes exporting commodities more expensive, so in the last few weeks traders exited some of their long positions in many commodities.

If Ukraine grain remains unable to be exported long term, the global corn and wheat supply will be limited and prices will need to rally to ration demand. If trade routes open, then prices have further downside potential. 

Weather over the next two weeks in the U.S. will be a major factor for yield potential.

Carry vs. inverse

In most years the corn crop is in a carry. Market carry is when the nearby futures contract is LOWER than a later one. Basically, a carry signals the market has plenty of supply available and is paying someone to hold grain until later. For hedgers storing grain, carry provides an opportunity to collect additional profit from their storage until later in the season when it is needed, and when basis values likely are trading at higher values.

An inverse is when the nearby contract is HIGHER than the contract after it. An inverse signals the market needs grain now. In this scenario, it costs hedgers to keep grain in storage because it will cost them to roll their futures forward in search of better basis values. 

Over the last 16 months the corn market has mostly been in an inverse market. However, from the 2013 harvest until spring 2021, the corn market was almost always in a carry. For hedgers a carry market tends to be more forgiving, because it involves moving, or rolling, sales further out in time, usually in consistent profit ranges. For the 2013 crop all the way through the 2019 crop marketing year there was always a carry of 16-30 cents available. On average there was a 24-cent carry to move or roll a sale from the December contract to the July contract.

Inverse markets are not as predictable or forgiving and occur less frequently in the corn market. Only 3 of the last 11 years have had an inverse (crop years: 2012, 2020, and 2021). Each of these inverse markets occurred for different reasons, and it is why predicting inverse outcomes is so difficult.

While inverse markets usually suggest it is better to move cash grain now instead of later, the futures side could be suggesting the opposite approach. This can be very confusing to farmers who are typically pure cash traders. Usually, this marketing phenomenon can leave them feeling like the best decision is to wait and price cash grain later. Hedgers on the other hand, need to evaluate the time value of money to hold grain in the bin, estimate basis value opportunity in the future, and assess the potential spread value between contract months. Regardless of being a cash trader or hedger, trading an inverse market can be extremely difficult because the markets are extremely volatile.

Market action

Usually, grain trading is relatively simple and straightforward when the market is in a carry. However, when an inverse comes along, the trades required to maximize profitability and reduce risk increase in difficulty and complexity. Below I have detailed three spread trades I made since last November on my 2021 corn crop. The reasons why I made the trades may seem complicated, but ultimately my goal for each trade was to minimize risk for my operation while trying to gain small profits during unusual market scenarios. 

Trade #1 – December to March Spread Trade

In January 2021, I sold 30% of my 2021 corn crop against December ’21 futures. By late November of 2021, my sold December futures position needed to move forward to a new contract month because I wanted to wait for better basis values sometime in the future.

I decided to move, or roll, my December contract to March because I only had 30% of my crop sold at that time. I chose the March contract because I was hoping that futures would rally further on the 70% of my unpriced corn I had left to sell. However, if the futures market did NOT rally, I figured a larger carry would then develop to either May or June. 

On the other hand, a rally would likely cause a market inverse, which would eliminate any carry for my 30% sold grain position. If this scenario happened, I thought I could then use the 30% sold hedge position to offset a cash sale to core my bins during the winter, which would be better than rolling my sales into an inverse and potentially losing money on the spread trade. 

Basically, I figured if futures rallied it would be more beneficial on 70% of my unpriced grain than it would hurt me through a lack of carry or taking a small inverse on my 30% sold grain position.

I waited until the last possible day to roll my December short position indicated by the red X in the chart below to the March contract.

Based upon data from the previous 9 years, it seemed likely the December/March corn futures spread may have more market carry opportunity during the last days of November. Unfortunately, as the above chart shows, the pattern of the previous years did not happen this year, and ultimately no profit was made on this trade.

In the last 9 years, carry ranged between 11-15 cents from the December to March contract. So, despite carry hitting just over 9 cents several times in late summer and early fall, I hedged my hedge position waiting for a bigger carry. I figured if the spread fell, futures would increase. The chart below shows that while I did miss just over 9 cents of market carry value on 30% of my hedged grain, the futures rallied more than 60 cents on the 70% of the grain I had not yet sold.

Trade #2 – March to July Spread Trade

From Thanksgiving to mid-February, futures continued to rally, and I sold another 40% of my corn crop against March futures. In December and January, the market seemed to be trading a similar pattern to the inverse that was present in the 2020 crop year, as seen in the chart below.

However, by early February the 2021 crop spread seemed to be changing course from how it traded the year before. I held out until mid-February to see if the inverse would work back to a carry (above 0 on the spread in the chart above). By Feb. 16 it seemed clear the market would stay an inverse, so I rolled all my ’21 crop sales (70% of total crop production) to the July contract at a 6-cent inverse or a cost of 6 cents to my overall position.

I could have rolled my March contracts to May for no loss on the same day, but the May/July corn futures spread the previous year ended up trading to a 40-cent inverse. Since there is a cost for hedgers to hold grain waiting for better basis values in a market inverse, I thought it was safer to roll everything to the July contract instead, rather than taking a chance on another spread. 

While an inverse tells the market to move grain now, basis values in mid-February were historically very low for that time of year and basis values tend to improve going into summer even in a year with an inverse. Therefore, I took the small 6 cent spread loss for a chance on better basis by July.

Trade #3 – July BACK to May Corn Spread

Eight days after I made the trade above, Russia invaded Ukraine, causing the commodity markets to move dramatically. The March contract went into the delivery process 4 days after the invasion, so the lead trading month on the corn board was the May contract. The May contract took a dramatic run higher compared to the July contract as seen in the chart below in early March.

The chart above shows over the last 9 years the spread between the May and July corn futures was consistently in a carry (below 0 in this chart), except for this year and the previous marketing year where it was in an inverse (a value above 0 in this chart).

The red X shows where I rolled my July short futures positions BACK to the May contract and collected 48 cents of profit on the trade in my hedge account. The red X is above the yellow line because the line represents the closing prices of the spread that day. The highest trade of the May/July spread that day was just over 52 cents, and it never traded that high again this year.

Summary

While the trades above may sound confusing, they are part of a larger risk management plan that included a basis trade strategy too. Next week I’ll finish explaining how my basis strategy correlated with these spread trades in more detail. 

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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