Going Against The Grain?

Corn/Oats Spread

The prices of corn and oats show a high statistical correlation. A similar growing season and the commonality of being used in the animal feed market explain this relationship. However, there are occasions where a move in one of these markets is followed by only a muted response or no response at all in the other market. These are the times when a spread trade opportunity can show up. Right now may be one of those opportunities.

Corn Oats Overlay Monthly

Corn Oats Overlay Monthly

With the US (the world’s largest corn grower) expected to harvest a record corn crop and Canada (the world’s second-largest oat grower) simultaneously producing the smallest oat crop in over two decades, there has been a divergence between the two markets. While most grains (including corn) plummeted to multi-year lows over the last couple of months, the oat market has been stuck in a trading range.

Corn Oats Spread Monthly

Corn Oats Spread Monthly

In the last four decades, there have only been a half-dozen times when the corn/oat spread has been at 50-cents or lower (basis the nearest-futures) on the monthly closing chart. Additionally, a ratio of 1.2:1 or lower has only been seen a handful of time in the same time span. Trades at ‘even money’ (when corn and oats are at the same price) have been even less frequent. The normal level for the relationship between corn and oats is around a premium of $1-per-bushel (premium corn) or 1.7:1.

Corn Oats Ratio Monthly

Corn Oats Ratio Monthly

The nearest-delivery contract September corn/oat spread sank below ‘even money’ in early August and oats have held the premium since then. The corn traded at a discount of as much as eighteen cents to the oat market last week. The problem, however, is that the First Notice Day for the September grain contracts is two days from now. This leaves no time to make a trade in these contracts. Therefore, traders should be monitoring the December spread.

While not quite as extreme as the September spread, the December corn/oat spread is still historically quite low. Right now the spread between the December corn contract and the December oat contract is +23 cents (premium corn). It touched a contract low of +16 cents on Monday. Unless a trend change occurs, the Christmas spread could be destined to trade below the ‘even money’ level as well.

Trend Change Signals

There are two simple signals that traders can use to identify a possible bullish trend change for the December corn/oat spread:

First, a close above the declining 30-day Moving Average (currently around +33 3/4 cents) would be noteworthy. The spread has not closed above the 30-day MA since early May. Plus, the 30-day MA proved accurate when it closed above the 30-day MA on March 6th to signal a bullish trend and it proved accurate when it closed back below the 30-day MA on May 13th to signal a bearish trend. The bearish trend has obviously not been negated yet.

December Corn Oats Spread Daily

December Corn Oats Spread Daily

Secondly, a breakout above the August high (currently at +43 cents) would alter the bearish price structure. The December corn/oat spread has not broken a previous month’s high since this year’s high was established on May 8th.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by buying one 5,000 bushel December corn contract and simultaneously selling one 5,000 bushel December oat contract if the spread closes above the declining 30-day Moving Average. Initially, the spread will be liquidated on a two-consecutive day close 5 cents below the contract low that precedes the entry.

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