May Soybean/Wheat spread: Time To Close Out

Winding It Down

On November 9th the IMC blog bought the May 2016 soybean/wheat spread at $3.62 1/2. This trade was based on a high-probability seasonal pattern than projected higher prices through early January.

May Soybean Wheat spread daily

May soybean wheat spread daily

The time window for this seasonal trade comes to a close on Friday. If the spread had a price pattern with strong momentum, we might continue to ride it and trail a stop. But there isn’t such a pattern. Therefore, we are going to go ahead and liquidate on Friday.

Trade Strategy:

On the long May 2016 soybean/wheat spread entered at $3.62 1/2, exit the position at the market-on-close on January 8th.

Advertisements

Grain Basket Spread: Out With a Profit

The Basket is Now Empty

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

Today we liquidated the position at a price of approximately -23 cents (premium the sum of the wheat and corn). This resulted in a profit of approximately +$1,925 per spread, not including commissions.

Nov-Dec 2016 Grain Basket spread dailyThe narrowing range of the last few months caused us to lower our exit target to a close at -30 cents or higher. This was triggered today. Now we are going to cool our heels on this spread for a while. To get us interested in a new position, the Nov-Dec 2016 Grain Basket spread or the July 2017 Grain Basket spread will have to drop to at least -$1.00 (premium the sum of the wheat and corn) or rocket to at least +$1.50 (premium beans). If that happens, we will start forming a game plan. Until then…

Grain Basket Spread: Change the Profit Target

The Grain Basket Spread

The blog initiated a hypothetical long position in the Nov-Dec 2016 Grain Basket spread on July 14th. The position consists of one long November 2016 soybean contract, one short December 2016 wheat contract, and one short one December 2016 corn contract.

The position was entered at approximately -61 1/2 cents (premium the sum of the wheat and corn). For the last few months, we have had a standing order to exit on a close at ‘even money’ or higher. This was due to the spreads previous excursions to where beans gained the premium over wheat and corn for a few days before it rolled right back over.

When Things Change, Be Flexible

Our standing target has not yet been hit. Since Memorial Day, the Nov-Dec 2016 Grain Basket spread has peaked just above -30 cents (premium the sum of the wheat and corn) several times and then rolled over. We have to acknowledge that this is working as a resistance area.

Nov-Dec 2016 Grain Basket spread daily

Nov-Dec 2016 Grain Basket spread daily

Furthermore, we initially bought the ‘red’ new crop Grain Basket spread when it was trading at a substantial price discount to the nearest-futures spread. The difference between the nearest-futures Grain Basket spread and the Nov-Dec 2016 Grain Basket spread has narrowed quite a bit since the summer. This gave away some of our edge. Therefore, we think it might be prudent to lower our target and look for a smaller profit.

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 -30 cents or higher instead of waiting for parity.

May Soybean/Wheat spread: Reentry Parameters Triggered

Back In the Saddle

Yesterday the blog bought the May 2016 soybean/wheat spread at $3.62 1/2. This re-positioned us back on the long side after last week’s attempt was stopped out right away. We are initially going to use a two-day close below $3.40 1/2 as our exit signal.

May 2016 Soybean Wheat spread daily

May 2016 Soybean Wheat spread daily

Last week the spread cracked important price support at the September low of $3.56. The immediate reversal higher triggered a Wash & Rinse buy signal, which is a failed bearish breakdown attempt. Hopefully, this will reinforce the seasonal pattern that points higher from now thru early January.

May Soybean/Wheat spread: Jump Right Back In

Not the Most Auspicious Start…

On November 5th the blog bought the May 2016 soybean/wheat spread at $3.56. The spread was exited on November 6th at $3.45 1/2. Taking this loss of $525 (not including commissions) per spread just the day after entry is certainly not a good way to start a new trade!

But we soldier on…

The premise of the May 2016 soybean/wheat spread is based on a seasonal pattern that shows that a two-month hold period has been profitable for the last decade and a half. The two-day close below the prior contract low, however, prompted us to get out.

May 2016 Soybean Wheat spread daily

May 2016 Soybean Wheat spread daily

If the spread were to make an immediate turnaround, it would trigger a Wash &Rinse buy signal. This would give us reason to get right back on the horse, so that’s exactly what we’re going to do.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by buying one 5,000 bushel May soybean contract and simultaneously selling one 5,000 bushel May wheat contract if the spread closes at $3.56 or higher. If filled, risk a two-day close of two cents or more below the contract low that precedes the entry.

May Soybean/Wheat spread: Seasonal Pattern + Support Test = A Good Trade Setup

A Compelling Seasonal Spread Trade

I published an article on Martin Kronicle about a high-probability seasonal spread. It’s the May 2016 soybean/wheat spread. You can see the whole article here:

http://www.martinkronicle.com/2015/11/04/seasonal-synergy-soybeanwheat/

With a strong track record of success, a respectable average return, and a chart that shows that the spread is currently testing price support, the stars have aligned for what we believe to be a good trading opportunity. Therefore, the IMC blog is going to take a hypothetical position on the long side of this spread.

May 2016 Soybean Wheat spread daily

May 2016 Soybean Wheat spread daily

Usually, we would wait for some sort of trend reversal before jumping in. But given the fact that today is the start of a high-probability seasonal trade and the fact that the spread is trading at a price that has already been tested a few times with quick recoveries, this seems like a decent place to initiate a position. In addition, the initial small risk size creates an attractive reward-to-risk ratio. So we’re going to go ahead and get after it.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by buying one 5,000 bushel May soybean contract and simultaneously selling one 5,000 bushel May wheat contract at $3.56 or better. Initially, we will exit on a two-day close below $3.46.

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.

Grain Basket Spread: The Entry Signal For the Late 2016 Spread Was Triggered

The Grain Basket Spread

Today the IMC blog entered a long position in what we call the Grain Basket spread. This is the difference between soybeans and the sum of wheat and corn.

The position would have been initiated by purchasing one 5,000 bushel November 2016 soybean contract at $9.70 3/4, shorting one 5,000 bushel December 2016 wheat contract at $5.95 1/2, and shorting one 5,000 bushel December 2016 corn contract at $4.36 3/4. Since the sum of the wheat and the corn is $10.32 1/4, the spread was purchased at a price of -61 1/2 cents (premium the sum of the wheat and corn).

Nov-Dec 2016 Grain Basket spread daily

Nov-Dec 2016 Grain Basket spread daily

Initially, the exit criteria it to bail out on a two-day close below -$1.07 3/4. This is a nickel below the June 30th contract low. If the Nov-Dec 2016 Grain Basket spread gets back up near the ‘even money’ level where the price of beans is equal to the sum of the wheat and corn we should have room to raise the exit level and lock in a profit.

The 2016 Grain Basket Spread: Placing Bets On a Crop That Doesn’t Even Exist Yet

The Grain Basket Spread

Most commodity traders are trading the closest delivery month contracts in the futures markets. This is where most of the liquidity is. Rightly so. The closer deliveries are more sensitive to changes in supply and demand. This causes them to move around more than the back month futures contracts. The greater market volatility often means more trading opportunities. However, trading opportunities can sometimes materialize in the distant-month contracts where they are seemingly hidden from the majority of traders. These opportunities develop under the radar as most traders don’t usually even monitor the distant month futures contracts, much less trade them.

We are of the opinion that some lucrative trading opportunities may currently be shaping up in distant delivery month futures contracts. Specifically, we are examining the grain markets. Here’s what we have ‘bean’ looking at:

Grain Markets: The ‘Big Three’

Our focus will be on three different grain markets: soybeans, corn, and wheat. Soybeans are the second-largest crop in the United States, corn is the largest crop in the United States, and wheat is the fourth-largest crop in the United States.

(Attach the weekly soybean, corn, and wheat overlay).

Soybeans Wheat Corn overlay monthly

Soybeans Wheat Corn overlay monthly

As you might expect, the relationship between soybeans, corn, and wheat is highly correlated. These grain markets have similar growing seasons (wheat actually has an additional growing season as well so both spring wheat and winter wheat are planted and harvested during the year) as they are planted in the spring and then harvested in the fall. So if a summer drought affected the beans it most likely harmed the corn and wheat, too. And if ideal growing conditions produced a bumper crop in corn then beans and wheat probably didn’t come off looking too shabby, either. This causes grains to generally trend in the same direction. Other factors such as the overall health of the global economy, demand for bio-fuels, and currency exchange rates have an impact on grain prices as well.

On the other hand, there are times when fundamental events will have a great impact on one particular grain crop and a muted influence on the other two. For instance, a summer drought in Russia may not directly hit corn and beans while it decimates the wheat crop. And if weather problems in South America cause demand for US soybeans to surge it may not have a direct impact on corn or wheat. These sorts of events can cause disparities in the relationship between grain markets, some of them quite significant. The disparities tend to be temporary, though. Several decades of price history reveal that the relationships between these three markets are consistently very strong. In past occurrences where the three markets experienced a divergence it was only a matter of time until they got back in sync. It has always been a question of ‘when’ and not ‘if’ these three amigos get back together. These strong correlations can lead to some great trading opportunities in the grain markets.

Spreading a Basket of Grains

We are analyzing the spread between soybeans and the sum of wheat and corn. We like to call this the ‘grain basket’ spread. To establish a long position in this spread one would need to be long one soybean contract, short one wheat contract, and short one corn contract for each spread position.

The price of the front month July soybean contract is trading about 31 cents over the sum of the price of the July wheat contract and the July corn contract. This is nothing spectacular. Since we are only interested in the spreads that hit levels that are historically extreme, we would simply pass this one by.

Historically, we consider the spread “cheap” when the beans trade at a discount of $1.50 or more under the sum of the wheat and corn. Conversely, we consider the spread “expensive” when the beans trade at a premium of $2.00 or more under the sum of the wheat and corn.

Grain Basket spread nearest-futures weekly

Grain Basket spread nearest-futures weekly

Since the 1960s, there has been only nine times when the spread made it to the upper level of $2.00 or more (premium beans) and about half a dozen times when the spread made it to the lower level of -$1.50 or less (premium the sum of wheat and corn). Most occurrences ultimately led to a reversal that send the spread back to even money and beyond. These were profitable opportunities for sophisticated traders who knew the way this grain basket spread operates.

Rationing the Grains in the Basket

Over the last few years, we’ve seen the grain markets skyrocket to historic highs. Three years ago, the US experienced the worst drought in over half a century. This propelled beans and corn to highs never seen before in history and wheat reached the second-highest price on record. Price extremes can cause the spreads to look extreme as well. To normalize the data, we compare the grain basket spread to the grain basket ratio. This tells us if we are really dealing with a high-probability trade opportunity or if we are just being fooled by price extremes on the underlying market sector.

Grain Basket ratio nearest-futures monthly

Grain Basket ratio nearest-futures monthly

Based on nearly forty-five years of price data, the ratio between soybeans and the sum of wheat and corn is expensive when it climbs 1.4:1 and it is cheap when it drops to 0.85:1. The ratio has only neared or reached this upper boundary half a dozen times in nearly half a century and it has only experienced the low side of the ratio five or six times in the same period.

Hidden Far Into the Future(s)

Currently, the July grain basket spread is at +31 cents (premium beans) and the July grain basket ratio is at 1.03:1. This is middle-of-the-road levels. As we stated before, it is of no interest to us.

July Grain Basket spread daily

July Grain Basket spread daily

.

Now here’s something that will make you sit up and take notice: the spread between the 2016 November soybeans and the sum of the December 2016 wheat and December 2016 corn is trading at -88 1/2 cents (premium the sum of wheat and corn). This is $1.19 lower than the nearest-futures July 2015 spread! Although it has not reached the historical extreme of -$1.50 yet, it has been heading that way and it’s a heck of a lot closer than the 2015 spreads are. The Nov-Dec 2016 grain basket spread has dropped about 67 cents from the mid-June peak. If this spread drops another 62 cents from here it will hit the -$1.50 mark.

Nov-Dec 2016 Grain Basket spread daily

Nov-Dec 2016 Grain Basket spread daily

What’s interesting is these are the 2016 new crop contracts, meaning that they won’t even been planted until next spring. So the growing price imbalance in this spread is for something that doesn’t even exist yet.

Nov-Dec 2016 Grain Basket ratio daily

Nov-Dec 2016 Grain Basket ratio daily

The low spread on the 2016 new crop grain basket is confirmed by the ratio. The ratio hit 0.91:1 this morning, which is just a stone’s throw from the 0.85:1 qualifying level.

(Attach the daily Nov-Dec 2016 grain basket ratio).

When to ‘Go Against the Grain’ and Be a Buyer

Examining the daily chart of the Nov-Dec 2016 grain basket spread, we see that this is the sixth time in the last seven months that the spread has dropped to -65 cents or lower. The previous five times, it never closed below -65 cents for more than two days in a row before making a sharp recovery.

This time something has changed. Not only did the spread break price support between the similar December and early June lows, but today could also mark the third day in a row with a close below -65 cents. This is a bearish breakdown.

Currently, we are cheering for a drop to -$1.50 or lower. This would officially qualify the Nov-Dec 2016 grain basket spread as a trade candidate on the long side.

From a pattern-driven outlook, though, a trader could look to go long if the bearish breakout fails. We like to call this the Wash & Rinse signal. It’s where a market cracks price support at a prior low, sets off a bunch of sell stops and algorithm-based sell signals, and then promptly turns right back around. This often leads to a sharp rally. It works in the outright markets and, surprisingly, works just as well in the spreads.

Keep Calm and Trade On

Even if the spread continues to plunge, we know that history indicates that prices at the boundaries on the historic low side don’t last. Especially since the crops for these particular delivery month contracts don’t even exist yet and they won’t even be planted this year! These three crops can be interchangeable from a planting perspective since a lot of acreage can be used to plant beans or corn or wheat. So if the spread/ratio between beans, corn, and wheat is still extremely low when the spring of 2016 rolls around then what farmer is going to want to plant soybeans?! They would obviously have a much higher profit margin in wheat or corn.

But what if the grains see their normal seasonal decline in the next couple of months? Maybe there’s a chance of seeing these long-dated spreads continue to rack up new contract lows. Or what if the Russians ban wheat exports or the Australian wheat crop is destroyed by drought while beans and corn just sit there? This could hammer the spread as well. Perhaps. Or perhaps not. But the important point is that extreme lows like this just don’t last in the grain spreads. The irrevocable Law of Supply and Demand will see to it that the imbalance is corrected. Even if the rally fades and the first attempt at a long position is exited at a loss, the probabilities have not changed. As a matter of fact, they may actually increase since the time duration at such an extreme low will have increased as well.

How to Trade This Spread…And All Spreads

To weather and unforeseeable storms, traders need to exercise sound position-sizing rules (never add to a losing position!) and risk management principles (never bet the farm on any one trade!) in order to stay afloat. Don’t led greed cause you to put on a position size that‘s much larger than is prudent. And don’t let fear or thoughts like ‘it’s different this time’ prevent you from getting back up if the spread gets knocked back down. Stay cool and use common sense. If you can survive the short-term adverse moves, you will be around to capitalize on the long-term probabilities.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by buying one 5,000 bushel November 2016 soybean contract and simultaneously selling one 5,000 bushel December 2016 wheat contract and one 5,000 bushel December 2016 corn contract if the spread between soybeans and the sum of the wheat and corn closes above -70 cents (premium the sum of the wheat and corn). If filled, we will initially risk a two-day close of 5 cents below the contract low that precedes the entry.