Grain Basket Spread: Let’s Set a Profit Target

The Grain Basket Spread

On July 14th a hypothetical long position was initiated in the Nov-Dec 2016 Grain Basket spread (long one November 2016 soybean, short one December 2016 wheat, and short one December 2016 corn) at approximately -61 1/2 cents (premium the sum of the wheat and corn).

We bought this distant month spread because of its unusually steep discount to the nearest-futures spread and also because it was approaching a level that is historically cheap.

At the beginning of the month, the beans were priced at a discount of one dollar to the sum of the wheat and the corn. On the nearest-futures monthly chart, whenever this Grain Basket spread dropped to a discount of one dollar or more and reversed, it ultimately inverted and went back up to a premium of +$1.50 (premium beans) or more.

Like a Broken Record

The problem is, the nearest-futures Grain Basket spread has not been inverted for over two years. It appears to be a distant-month contract anomaly. Therefore, we are going to shorten our timeframe a bit and put a profit target on the current position.

Over the last year, it appears that the Nov-Dec 2016 Grain Basket spread has had a hard time keeping its head above the ‘even money’ mark:

-After reaching a premium of +12 cents last July, the spread rolled over and dropped nearly 56 cents in a month.

-By late September the spread was a half-cent away from the July top. It didn’t last long. The spread dropped 61-cents over the next four weeks.

Nov-Dec 2016 Grain Basket spread daily

Nov-Dec 2016 Grain Basket spread daily

-On November 11th the Nov-Dec 2016 Grain Basket spread spiked to a new multi-month high of +14 1/4 cents (premium beans). Was this finally a bullish breakout?! Nope. Three weeks later, it had dropped to a new multi-month low as it lost 87-cents.

-The next time the spread cleared the ‘even money’ mark was in late February. It lasted two days. One month later, the spread had declined 70 cents from the peak.

-On April 27th we saw a one-day close above ‘even money’ and then a pullback for the rest of the week. On Cinco de Mayo, there was one more close above ‘even money’ when November 2016 soybeans gained a two-cent premium over the sum of the December 2016 wheat and December 2016 corn. From this top, it began a nearly two-month decline and posted a new contract low of -$1.02 3/4 on the last day of June.

If You Can’t Beat ‘Em…

Based on the behavior pattern of the last year, it seems that the logical thing to do is exit a long position if the Nov-Dec 2016 Grain Basket spread closes at ‘even money’ or higher. We can then look for a reentry if it drops back to a discount of half a dollar or more. If Murphy’s Law comes into play and the spread finally makes a breakout and never looks back…well, at least we got a little piece of the action and bagged another profit. We’ll simply take the winnings and go shopping for some new bargains elsewhere.

Trade Strategy:

On the long position in the Nov-Dec 2016 Grain Basket spread entered at approximately -61 1/2 cents (premium the sum of the wheat and corn), exit on a close at ‘even money’ or higher.

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