Corn/Oat Spread: Cancel the Short Sale Order…For Now

Head For the Sidelines

The IMC blog has been working an order to short the September corn/oat (x2) spread on a rally to ‘even money’.  With the First Notice Day coming up the day after tomorrow, we are going to withdraw the order to short the September spread.

December Corn Oats (x2) spread daily

December Corn Oats (x2) spread daily

The December spread has never been to the even money mark.  If we went short up there, we would be fading a breakout to new highs.  It seems that the more prudent course of action would be to monitor the December corn/oat (x2) spread and see what happens if/when it reaches the ‘even money’ mark.  Then we can decide if we should get short at that point or sit on our hands if it’s still rocketing higher.

Trade Strategy:

Cancel the hypothetical order to sell one 5,000 bushel September corn contract and simultaneously buy two 5,000 bushel September oat contracts at ‘even money’. 

Corn/Oat Spread: Sell the Bounce!

Another Day, Another Grain Spread Play

Wow, we’ve made a ton of posts on various grain spreads recently!  The big run over the last couple of months has pushed some spreads into historically high territory where the ground was fertile for prior bear markets to be sown.

Another grain spread that may be ready for short sellers to harvest is corn vs. oats.  Let’s take a look and see why.

First of all, the correlation between corn and oat prices has been very strong for the last several decades.  I bet if I had the cash prices for the last hundred years readily available it would show the same thing.

Corn Oats overlay weekly

Corn Oats overlay weekly

For the IMC blog, a strong correlation between two markets is the first order of business in hunting for spread trading opportunities.  Remember, we look for commodity spreads that hit historic extremes (hitting multi-year highs, outliers, pushing past two standard deviations, etc.) and then bet on a reversion to the mean.  So a strong correlation is a necessary foundation for this strategy to work.  And the corn and oat markets have it!

The Ratio Says It All

A few weeks ago, the corn/oat ratio ended the week at 2.22:1 and nearly matched the January 2012 multi-year high of 2.24:1.  At this level, the price of corn is more than double the price of oats.

Corn Oats ratio weekly

Corn Oats ratio weekly

A ratio of 2.2:1 is historically very expensive.  Over the last forty-five years, the corn/oat ratio has made it to 2.2:1 or higher not even a dozen times.  Each occurrence has been followed by a major bear market decline.  There’s no reason to think this pattern will stop now.

Every prior run to 2.2:1 or higher has been followed by a decline to 1.45:1 or lower.  Therefore, once the ratio shows that the trend has reversed and turned bearish, 1.45:1 should be our minimum downside target.

The Spread

Since corn is double the price of oats, we will normalize the spread relationship by trading one corn contract against two oat contracts.

Three weeks ago, the corn/oat (x2) spread had closed a nearly four-year high of +42 1/4 cents (premium corn) on the weekly nearest-futures chart.  This is only the fifth bull market since 1970 that has reached +40 cents (premium corn) or higher, basis weekly nearest-futures chart.  It certainly qualifies as an extreme.

Corn Oats (x2) spread weekly

Corn Oats (x2) spread weekly

The bear markets that followed the prior four bull markets sent the corn/oat (x2) spread down to final lows of -$1.15 3/4 (premium oats) in 1977, -$3.83 1/2 (premium oats) in 1988, -85 1/4 cents (premium oats) in 1997, and -$5.63 1/2 (premium oats) in 2014.

Basis a futures spread position consisting of one short corn contract and two long oat contracts, the size of the bear market declines from the highs to the lows were $8,737.50 into the 1977 bottom, $21,212.50 into the 1988 bottom, $7,100 into the 1997 bottom, and $31,625 into the 2014 bottom.  This indicates to us that the bear markets in this spread are worth trading!

The September Spread

The September corn/oat (x2) spread surpassed the ‘even money’ mark on May 25th.  The current contract high of +18 1/4 cents (premium corn) was made three weeks ago on June 3rd, which is the same day that the nearest-futures July spread posted its multi-year high of +42 1/4 cents (premium corn).

The nearest-futures July spread has collapsed over the last three weeks.  Today it touched an intraday four-month low of -40 cents (premium oats).  The September spread is moving at a slower pace as it has only pulled back to a six-week low.  Given the size of the selloff, a bear market bounce would not be all that surprising.

September Corn Oats (x2) spread daily

September Corn Oats (x2) spread daily

For the first time in a month, the September corn/oat (x2) spread has spent an entire week below the ‘even money’ mark.  Therefore, this level is now an important psychological barrier.  Furthermore, a Fibonacci .618 retracement of the current decline sets technical resistance just beyond this psychological level at +2 1/4 cents (premium corn).

Based on the idea that the current break is a bit stretched and due for a bounce…

And that the ‘even money’ mark will offer psychological resistance…

And that a Fibonacci .618 resistance line is located just a couple of pennies above it…

The blog’s initial strategy will be to short the September corn/oat (x2) spread on a bounce to ‘even money’ and risk to new contract highs.  Once we have a decent size open profit on the initial position we will look for a setup to start pyramiding it.

Trade Strategy:

The blog will work a hypothetical order to sell one 5,000 bushel September corn contract and simultaneously buy two 5,000 bushel September oat contracts at ‘even money’.  If filled, exit on a two-day close above +20 cents (premium corn).

Corn/Oat Spread: The Profits In This Spread Were Harvested Today!

Corn/Oats Spread Exit

The blog initiated a hypothetical long position in the March corn/oat spread at -2 cents (premium oats) on October 8th and added another at +45 1/2 cents (premium corn) on November 13th. Originally, these were the December spreads and then they were rolled to the March contracts on November 26th.

The March corn/oat spread made a two-day close below the rising 30-day Moving Average for the first time since early October and signaled a bearish trend change. This triggered the exit signal for the entire position at today’s close of +96 1/4 cents (premium corn). The trade resulted in hypothetical profits of $4,912.50 on the initial position and $2,537.50 on the ‘add-on’ position, yielding a total profit of $7,450 on the trade (not including commissions).

March Corn Oat Spread Daily

March Corn Oat Spread Daily

The initial risk on the trade was approximately $1,337.50. In November the exit parameters were raised in order to eliminate the initial risk and lock in a trailing profit on the initial position. This gave us room to add another spread with an initial risk of approximately $1,375. So even though the position size was doubled, the biggest risk ever allowed for on the entire trade was $1,375. This was a function of trailing stop levels and only increasing the position size when the current position had a healthy open profit. Therefore, the hypothetical profit of $7,450 with a maximum risk of $1,375 produced a return of a little better than 5:1 on the trade.

What Good Trading Is All About

In our opinion, this corn/oat spread is a great example of what we consider to be a successful spread trade campaign:

First, a high-probability situation was identified (corn was trading at a discount to oats).

Second, a long position was entered only after a bullish trend change was signaled (via a close above the declining 30-day Moving Average for the first time in several months).

Next, the position size was increased only when the initial trade risk was eliminated and a new setup with a minimum reward-to-risk expectation of 3:1 was identified.

Finally, the entire position was liquidated without hesitation once a bearish trend change was signaled (via a close below the declining 30-day Moving Average for the first time in several months).

There is never any guarantee that a trade will work, of course. It’s all speculation and risk. But we have found that applying these rules consistently to each and every trade provides a positive edge over the long-term.

Corn/Oat Spread: Time To Roll To The March Contracts

Corn/Oat Spread

The blog entered a long position in the December corn/oat spread at ‘even money’ on October 8th and added another at +47 1/2 cents (premium corn) on November 13th.

This week the oat market plunged. The market is off nearly 22% from last month’s peak while the corn market is actually up 22% from last month’s low. This sent the December corn/oat spread to a nearly five-month high of +82 3/4 cents (premium corn) this morning.

December Corn Oat Spread Daily

December Corn Oat Spread Daily

The oat market has been the one market that did not participate in this year’s bear market in the grains. It was certainly not for lack of supply. Transportation was the problem. Oat shipments out of Canada (the world’s largest oat exporter) were delayed because record grain and oil seed crops created a shortage of rail cars and bogged the rail system. Now that the backlog has eased, oat shipments are coming in fast and furious and the corn/oat spread is returning to the mean.

March Corn Oat Spread Daily

March Corn Oat Spread Daily

First Notice Day for the December grain contracts is on Friday and the markets are closed tomorrow for Thanksgiving. Therefore, long positions need to be rolled over by today’s close to avoid possible delivery notices. The December corn/oat spread has been rising faster than the March spread and has now gained a premium over the March spread. One can now roll to the March contracts with a small premium on the December spread to pay all of the commissions. How cool is that?

When we started the trade, our minimum target was the one-dollar mark (premium corn). This could soon be achieved. We do know, however, that a large majority of the prior declines below the 50-cent level have been followed by rallies to +$1.50 or higher. Therefore, we will assess the situation after the one-dollar level has been reached. If the trend is still bullish, we will continue to stay on for the ride. Depending on the pattern that plays out, we may even look for a low-risk setup to add more to the long March corn/oat spread position in order to take full advantage of the move.

Corn Oat Spread Monthly

Corn Oat Spread Monthly

Trade Strategy:

For tracking purposes, the blog will roll the two long December corn/oat spreads (the initial position entered at ‘even money’ and the ‘add-on’ entered at +47 1/2 cents) to the March December corn/oat spreads while the December spread is trading at a premium of +2 cents or more to the March spread. Risk the March spreads to a two-day below the rising 30-day Moving Average.

Corn/Oat Spread: ‘Add-On’ Entry Signal Triggered

Corn/Oats Spread

On October 8th the blog entered a hypothetical long position in the December corn/oat spread at ‘even money’ when the spread closed above the declining 30-day Moving Average. Initially, we were risking a two-day close below -26 3/4 cents (premium oats). Now that the spread has been above the 30-day MA for over a month straight, we can eliminate the initial risk and even lock in a trailing profit by exiting this initial position on a two-day close below the rising 30-day MA.

December Corn Oats Spread Daily

December Corn Oats Spread Daily

Yesterday the blog entered another hypothetical long position in the December corn/oat spread at +47 1/2 cents (premium corn) when the spread closed above the August high of +43 cents. For this new ‘add-on’ position we are going to risk a two-day close below +20 cents (2 cents below the November 4th reaction low). Once the rising 30-day MA reaches +20 cents or higher, we will then risk a two-day close below the 30-day MA for both the initial position and the ‘add-on’ position.

We expect the corn/oat spread to eventually hit one-dollar (premium corn) or higher. Therefore, we will continue to watch for more low-risk setups to increase our size in the long corn/oat spread while keeping the overall trade risk steady or shrinking.

Corn/Oat Spread: “Add-On” Trade Setup

Corn/Oats Spread

The December corn/oat spread retreated 18 1/2 cents from the Halloween high. This pullback is big enough to provide a setup for adding to the long position that we entered at the ‘even money’ level nearly a month ago.

The Halloween high of 40 1/2 cents (premium corn) sets near-term resistance. This is closely followed by the August high of 43 cents. A breakout above these tops would indicate that the December corn/oat spread is still on track for our minimum target at the one-dollar mark (premium corn). Therefore, traders can use this as a trigger to add to long positions.

December Corn Oats Spread Daily

December Corn Oats Spread Daily

Trade Strategy:

For tracking purposes, the blog will make a hypothetical ‘add-on’ 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 August high of 43 cents. If filled, risk a two-day close of 2 cents below the November pullback low that precedes the entry.

Corn/Oat Spread: Trade Signal Triggered

Corn/Oats Spread

Yesterday the spread between December corn and December oats closed at ‘even money’ where they finished above the declining 30-day Moving Average for the first time in five months. This triggered a bullish trend change.

December Corn Oats Spread Daily

December Corn Oats Spread Daily

A hypothetical trade for the blog was triggered to buy one 5,000 bushel December corn contract and simultaneously sell one 5,000 bushel December oat contract at ‘even money’. Initially, the exit strategy is to liquidate the spread on a two-consecutive day close above -26 3/4 cents (premium oats).

At a minimum, we are looking for the spread to return to the one-dollar level (premium corn). If some low-risk setups occur along the way, we will discuss whether or not using them as opportunities to add to the long position in the December corn/oat spread would be a good idea.