Grain Basket: Roll to the Summer Spreads

Stay Short

The IMC blog entered a short position in the May Grain Basket spread (the difference between the price of one May soybean contract and the sum of one May wheat contract and one May corn contract) at +$2.16 (premium beans) on February 13th.

With the upcoming First Notice Day for the May grain contracts, we are going to roll to the July contracts.

July Grain Basket spread daily

July Grain Basket spread daily

After cracking support at the rising 100-day Moving Average in February, the Grain Basket slumped to multi-month lows.  It has rebounded over the last couple of weeks, but the now declining 100-day MA should provide technical resistance and cap the rally.

The April 11th multi-month low of $1.29 1/2 sets near-term price support.  A break below this price should clear the way for a collision with the psychological one dollar mark.  If the July Grain Basket does hit a new low for 2017 the blog will be watching closely to see if a setup materializes that would allow for an additional ‘add-on’ short sale to take advantage of the continued descent.

Trade Strategy:

Exit the short May soybean contract, long May wheat contract, and long May corn contract and simultaneously sell  short a short July soybean contract, buy a July wheat contract, and buy a July corn contract at the market-on-close on Tuesday, April 25th.  Risk the July grain basket spread to a two-day close above +$2.80. 

 

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Minneapolis/Kansas City Wheat Spread: Reset For the July Spread

Waiting for a Reversal

The IMC blog is holding a short position in the May Minneapolis/Kansas City wheat spread that was entered at +97 cents on February 10th.

The spread has rebounded sharply over the last two weeks and is testing the contract highs.  Therefore, we are going to liquidate the May spread and set parameters to short the July spread if it backs off.

July Minneapolis Kansas City Wheat spread daily

July Minneapolis Kansas City Wheat spread daily

We’ve established before that the Minneapolis hard red spring wheat is currently too pricey in comparison to the Kansas City hard red winter wheat.  It’s been this way for months, though.  While we still intend to be short, a breakout to new contract highs could keep it running indefinitely.  Hence, the strategy of waiting for the July spread to start back down before getting short again.

Trade Strategy:

Exit the hypothetical short position in the May Minneapolis/Kansas City wheat spread at the market-on-close on Tuesday, April 25th. 

Place a new order sell one July Minneapolis wheat contract and simultaneously buy one July Kansas City wheat contract if the spread closes below +$1.10.  If filled, risk a two-day close of three cents above the spread contract high that precedes the entry (currently at +$1.20 cents). 

Grain Basket Spread: Is the Bear Coming Out of Hibernation?

The Grain Basket Spread

I’ve traded the spread between soybeans and the sum of wheat and corn for many years and I’ve also posted about it on this blog a few times.  I nicknamed this spread the grain basket.  And sometimes it has been known to make baskets of money!  Based on current conditions, it appears that the grain basket spread may be shaping up for a new trading opportunity.

Price Correlation

Historically, the price relationship between soybeans, wheat, and corn has mostly been a highly-correlated affair.  Notice the word “mostly.”  There have been times when the correlation seemed to weaken.

For instance, we’ve seen a drought in Russia scorch the wheat crops and send wheat prices rocketing while it had no effect on world prices of beans and corn.  There have also been major hits to the South American bean crop that sent US soybeans to the moon, while corn was up modestly and wheat did nothing.

soybeans-wheat-corn-overlay-nearest-futures-monthly

Soybeans Wheat Corn overlay (nearest-futures) monthly

These divergent moves produced a drop in correlation, but they have always proved to be temporary events.  Over the long haul, the three grains have always gotten back in sync.  That’s what makes them such an attractive candidate for spread trades.

Historical Boundaries

As readers know, the IMC blog only takes an interest in the spreads that are at historical extremes.  Due to the mean-reverting nature of commodities, we believe that a spread trading at an historical extreme has a high-probability of making a sizable reversal and is worth betting on.  The trick, of course, is timing that reversal.

So what constitutes as an historical extreme?  Good question.  Here’s my way of looking at it.

Initially, a spread that has moved more than two standard deviations from the mean is a good candidate.  Remember, roughly 95% of all data values in a data distribution fall within two standard deviations from the mean.  So once a spread gets past the two standard deviation signpost, it’s stretched pretty thin.

Now, if you want to break it down into even simpler terms and shoot for a less technical answer, how about this: a spread is considered to be trading at an historical extreme when it reaches a price level that has only been reached infrequently (if ever) and has never been a sustainable level.

Using the grain basket spread as our example, take a look at nearly half a century of monthly price history.  Notice that there have only been a total of six bull markets that ran the spread up to three dollars or higher (premium beans).  Also, the longest consecutive run of month-end closes at three dollars or higher was four months.  Therefore, we can consider the spread to be “expensive” and at an historical extreme when beans command a premium of $3-per-bushel over the sum of wheat and corn.

grain-basket-spread-nearest-futures-monthly

Grain Basket spread (nearest-futures) monthly

Conversely, we can consider the grain basket spread to be “dirt cheap” and at an historical extreme when the sum of wheat and corn gain the upper hand and trade at a premium of two dollars or more over the price of soybeans.  Only three bear markets in the last fifty years have brought the spread to levels that low!

Grain Expectations

First off, let’s establish this basic and very important fact: It is absolutely impossible to know with certainly what the future will be.  Otherwise, palm readers and tarot card shops would not be located on the sketchy side of town.  And people who use Ouija boards and Magic 8 Balls would have their own yachts.

But what we can know is what the outcome probabilities are for future events.

There is a very important difference here.

That being said, notice that all six of the bull markets that ran the grain basket spread to three dollars or higher (premium beans) were followed by bear markets that erased the entire premium from the beans.

Therefore, a trader who gets positioned on the short side of the grain basket spread after a reversal signal occurs at $3-per-bushel or higher should be targeting a return to ‘even money’ or lower.  This will help you assess the reward-to-risk ratio on your trade setups and pyramid positions.

The Improbable Still Happens

Although I just picked on the fortune tellers for trying to divine the future, it does not mean that people like us who focus on the probabilities are completely off the hook.  Some people tend to forget that probabilities are not guarantees.  The improbable still happens!  And sometimes more often than we’d like to think.

Consider the Chicago Cubs winning the World Series last year or the Patriots coming back to win the Super Bowl in overtime last night…

Or the Brexit vote last summer or Trump’s election victory three months ago!

This is why you have to learn to bet according to the probabilities to become a good trader, but then you have to learn to manage risk according to the possibilities to become a great trader.

Current Outlook

The May grain basket spread (the difference between the price of one May soybean contract and the sum of one May wheat contract and one May corn contract) broke out of a multi-month trading range at the end of 2015 and has been trending higher since then.

During this bull run, the spread stayed above technical support at the rising 100-day Moving Average…until a month ago when it made a two-day close below the 100-day MA for the first time in over a year.

may-grain-basket-spread-dailyThe spread quickly rebounded and recovered nearly three-quarters of the pullback from the December peak.  However, prices softened over the last couple of weeks and the 100-day MA is being tested once again.

If the mid-January bounce turns out to be a secondary (lower) high and the May grain basket spread closes back under the 100-day MA, it may be time to start betting that the bull market is over.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 5,000 bushel May soybean contract and simultaneously buying one 5,000 bushel May wheat contract and buying one 5,000 bushel May corn contract if the spread between soybeans and the sum of the wheat and corn closes below the rising 100-day Moving Average (currently at +$2.22 1/4).  If filled, risk a two-day close of 5 cents above the contract high that precedes the entry. 

Minneapolis/KC Wheat Spread: Use the Ratio for Timing the Entry

Spring Forward

Just a week ago, it was time for us to ‘fall back’ here in the US.  And now we’re less than two weeks out from Thanksgiving!  This brings the Christmas delivery contracts right into view.

Since the futures markets are pricing in the future, we think it’s now time to move our recommendation for a December spread trade into the future as well.  Always good to stay a step ahead of the crowd.

The blog is currently working an order to short the December Minneapolis/Kansas City wheat spread.  We are simply going to move the recommendation over to the March 2017 spread now.

march-minneapolis-kansas-city-wheat-ratio-daily

March Minneapolis Kansas City Wheat ratio daily

The entry parameters for this trade are going to be tweaked slightly.  Initially, we were going to short the December spread once it cracked support at the rising 75-day Moving Average.  The December spread has not done this yet, but the March spread already did this and recovered.  So that’s a failure.

However, the March Minneapolis/Kansas City wheat ratio has held above the 75-day MA this entire time.  It’s been eight months since the ratio last closed below the 75-day MA.  Therefore, we are going to wait for the ratio to break support before initiating a short position in the March Minneapolis/Kansas City wheat spread.

Trade Strategy:

Cancel the hypothetical order to short the December Minneapolis/Kansas City wheat spread.  Place a new order sell one March Minneapolis wheat contract and simultaneously buy one March Kansas City wheat contract if the ratio between the two contracts closes below the rising 75-day MA (currently near 1.19:1).  If filled, risk a two-day close of three cents above the spread contract high that precedes the entry (currently at +$1.07 1/4 cents). 

Kansas City/Chicago Wheat Spread: Bag the Profits!

A Change of Trend

The IMC blog is holding a long position in the December Kansas City/Chicago wheat spread that was entered at the equivalent of -12 1/4 cents (premium CBOT wheat) on July 6th.  An ‘add-on’ position was entered at the equivalent of +7 3/4 cents (premium KC wheat) on August 26th.

Initially, we proposed the thesis that Kansas City wheat would not stay at a discounted price to the Chicago wheat.  Once a technical trend change signal occurred, we initiated a long position.  As the move higher confirmed our outlook, another setup occurred that allowed us to add to the position.

Based on the history of the KC/Chicago wheat spread, we expected a minimum return to where the KC wheat would trade at a premium of 35 to 40 cents or more over the Chicago wheat.  That may still be the case.  However, the price action of the last several days indicates that the spread is back on the defensive.

The Magic of Thirteen

The nearest-futures KC/Chicago wheat spread has found an important inflection point around +13 cents (premium KC wheat).  There’s just something about how this Lucky 13 level that has determined the fate of this spread for nearly two years.  It’s almost spooky.  And we’re not pointing it out just because it’s getting close to Halloween, either!

Just take a look at how it has played out and judge it yourself:

After a five and a half month bear market decline of nearly $1.33, the KC/Chicago wheat spread bottomed at +13 1/4 cents in December 2014.  A sizable bounce followed, indicating that the December low was major support.

The spread then retreated again and bottomed out at +13 cents in March of 2015.  This created a potential double bottom on the chart.  This was confirmed as the spread than rocketed 33-cents higher over the next month.

The KC/Chicago wheat spread reversed in April 2015 and bottomed once more at +13 cents in the second half of the month.  The nearly 23-cent rally that unfolded over the next month then created a potential triple bottom on the chart.

The third time was not the charm for this spread!  In the second half of June 2015, the nearest-futures KC/Chicago wheat spread made a two-day close below +13 cents.  This was a major support breach and things unraveled quickly.  The spread inverted before the month was out.

Now that the +13-cent support level had been broken, it became a major resistance level.  This is an important charting principle.

kansas-city-chicago-wheat-spread-nearest-futures-daily

Kansas City Chicago Wheat spread (nearest-futures) daily

The point was proven when the spread bottomed at an eight-year low of -40 1/4 cents (premium CBOT wheat) in early November 2015 and then started on the road to recovery.  A couple of weeks after the new year started, Kansas City wheat finally closed with a premium over the Chicago wheat for the first time in nearly seven months.  After a correction into early February, the bull run resumed.  This multi-month climb finally stopped on March 16th at a price of…+13 cents (premium KC wheat)!

The mid-March high marked a major turning point.  The nearest-futures KC/Chicago wheat spread was inverted again by early April.  The decline lasted for nearly three and a half months.  By the time it bottomed again at the end of June, the spread was only a nickel away from the multi-year low that it had hit in 2015.

Just like a pendulum, commodity spreads have a tendency to swing from one extreme to the other.  So it’s no surprise that from the depths of the Q2 lows, the KC/Chicago wheat spread turned back up.

A couple of months into the rally and the KC/Chicago wheat spread had made it all the way back up to +13 1/4 cents (premium KC wheat).  This occurred on September 2nd.  The spread closed at +13 cents the next day and then backed off the following day.  It looked like the spread may have once again crested at +13 cents and was ready to start another decline.

Then something interesting happened…

The KC/Chicago wheat spread recovered and made a two-day close above +13 cents on September 8th and 9th.  This hadn’t happened since the summer of 2015.  Now that the +13-cent resistance level had been broken, it once again became a major support level.

Furthermore, this put it above the prior top at the mid-March high.  The bulls were firmly in control now.

However…

This week the December KC/Chicago wheat spread –which is currently the nearest-futures spread-  kicked off the new month and the new quarter with a close back below +13 cents.  With just a few hours of trading left to go for the week, it appears that the spread will have spent the entire week below +13 cents.

By clearing the mid-March high and then dropping back under it, the nearest-futures KC/Chicago wheat spread triggered a Wash & Rinse sell signal.  This is a good reason to bag the profits on the long spread position and get to the sidelines.

Moving Average Confirmation

In addition to the Wash & Rinse sell signal, the December KC/Chicago wheat spread triggered a bearish trend change when it closed below the rising 30-day Moving Average for the first time in several months.

Recall that we initiated the long position in early July when the spread had made a two-day close above the declining 30-day MA for the first time in over three months.

december-kansas-city-chicago-wheat-spread-daily-30-day-ma

December Kansas City Chicago Wheat spread daily (30-day MA)

Now that the spread is closing back below the 30-day MA –especially since it will close below the 30-day MA every single day this week- it takes away our reason to be long.  For the last year, the 30-day MA has been a highly-accurate indicator for which side of the December KC/Chicago wheat spread to be positioned on.  Don’t ignore it.

Furthermore, look how things turned out when the spread closed below the 30-day MA six months ago at the end of March.  The sell-off continued for another three months.  If we’re lucky, perhaps we can book some profits here and then get a reentry signal after a sizable decline gives us another setup at much lower levels.

Trade Strategy:

On the December Kansas City/Chicago wheat spread that was entered at the equivalent of -12 1/4 cents (premium CBOT wheat) and the long ‘add-on’ position was entered at the equivalent of +7 3/4 cents (premium KC wheat), exit at +8 1/4 cents or better. 

Kansas City/Chicago Wheat Spread: A Setup To Pyramid

On a Tear

The IMC blog entered a long position in the September Kansas City/Chicago wheat spread at -13 3/4 cents (premium CBOT wheat) on July 6th.  The spread reached a three and a half month high just this week before pulling back.

The current pullback gives us the setup we need to add to the position.  Quite simply, traders can add on a close above the August 2nd watermark high of +5 1/4 cents (premium KC wheat) and risk to just below the current pullback low.  Nice and neat.

September Kansas City Chicago Wheat spread daily

September Kansas City Chicago Wheat spread daily

Historically, inversions in the KC/Chicago wheat spread were followed by reversals where the KC wheat would go back to a premium of 35 to 40 cents or more over the Chicago wheat.  So buying a close above +5 1/4 cents (premium KC wheat) should leave plenty of profit potential for this ‘add-on’ trade.

‘Add-On’ Trade Strategy:

Place a hypothetical order to buy one September Kansas City wheat contract and simultaneously sell one September Chicago wheat contract on a close above +5 1/4 cents (premium KC wheat).  If filled, risk a two-day close of three cents below the pullback low that precedes the entry (currently at -4 1/4 cents).

Kansas City/Chicago Wheat Spread: Follow the September Spread

We’d Like More Time

Last week the July Kansas City/Chicago wheat spread hit a new contract low of -24 cents (premium CBOT wheat).  The ‘cheap’ got even cheaper.

And on the nearest-futures monthly chart, the KC/Chicago wheat spread is even lower at -31 1/2 cents.  This is only the sixth time in forty-five years that KC wheat has been priced at a discount this big!  Profit opportunity is a brewin’ here, folks.

Kansas City Chicago Wheat spread (nearest-futures) monthly

Kansas City Chicago Wheat spread (nearest-futures) monthly

The blog currently has an outstanding order to buy the July KC/Chicago wheat spread on a recovery of the similar lows established back in November and February.  But the thing is, July grain contracts will have to be rolled in about five weeks and we don’t even have a position in it yet!  So we’re gonna start stalking the September spread for a trade setup instead.

The September Kansas City/Chicago wheat spread bottomed at -3 cents (premium CBOT wheat) on February 17th and bounced.  After breaching this support level at the end of April, the spread failed to recover.  Now that this prior support level has been broken, it turns into a resistance level.

Coincidentally, the May 9th bounce high –which also marks the current high for the month-is located at -3 3/4 cents.  This is just three-quarters of a cent below the February low of -3 cents so it acts as a reinforcement of the resistance level.  Therefore, we can use a close above this level as our trigger to get positioned on the long side of the September Kansas City/Chicago wheat spread.

September Kansas City Chicago Wheat spread daily

September Kansas City Chicago Wheat spread daily

Also, note that the declining 30-day Moving Average is currently located near -6 cents.  To trip the wire on our entry criteria, the spread will have to close above the 30-day MA for the first time since late March.  This could serve as good confirmation.

Trade Strategy:

Cancel the hypothetical order to buy one July Kansas City/Chicago wheat spread.  Work a new hypothetical order to buy one September Kansas City wheat contract and simultaneously sell one September Chicago wheat contract if the spread closes above -3 cents (premium CBOT wheat).  If filled, risk a two-day close of three cents below the contract low that precedes the entry.

Kansas City/Chicago Wheat Spread: New Lows. What to Do?!

Down & Out

The IMC blog was holding a long position in the July KC/Chicago wheat spread that was entered at the equivalent of at + 4 cents (premium KC wheat) on November 30th.

The position was liquidated on May 3rd at -15 cents (premium CBOT wheat) because the spread had closed below -13 cents for two days in a row.  This resulted in a loss of -$950 per spread.

Despite the stop-out, the KC/Chicago wheat spread is still a great candidate for a trade on the long side.  This is because the higher-quality KC wheat never stays priced at a discount to Chicago wheat.

Therefore, we are going to issue criteria to get back in the saddle.

Support Becomes Resistance

The July KC/Chicago wheat spread had important price support at the similar lows from November and February at -6 1/4 cents and -7 cents, respectively.  The break below these lows was the reason we got out.

July Kansas City Chicago Wheat spread daily

July Kansas City Chicago Wheat spread daily

Now that these old lows have been breached, this support level changed into a resistance level.  Therefore, a close back above the November and February lows could indicate that capitulation has occurred.  If so, we’d have a good reason to get back in.

In addition, a close above these lows would mean that the spread is also closing back above the declining 20-day Moving Average for the first time since late March.  This should confirm that the down trend has ended.

Trade Strategy:

Work a hypothetical order to buy one July Kansas City wheat contract and simultaneously sell one July Chicago wheat contract if the spread closes above -7 cents (premium CBOT wheat).  If filled, we will initially risk a two-day close of three cents below the contract low that precedes the entry.

Kansas City/Chicago Wheat Spread: Roll to July

Thinking of Summer

Well, boys and girls, next week is the First Notice Day for the May grain contracts.  Unless you actually want to take delivery of this stuff, it’s time to roll out to the summer contracts.

The blog is holding a hypothetical long position in the May KC/Chicago wheat spread that was entered at the equivalent of at -3/4 cents (premium CBOT wheat) on November 30th.

Several months into this trade, the Kansas City wheat is still priced at a discount to the Chicago wheat.  This is unusual because the KC wheat is a better grade than the CBOT wheat.  Therefore, we will side with history and continue to favor a return to the KC wheat having the premium.

May Kansas City Chicago Wheat spread daily

May Kansas City/Chicago Wheat spread daily

In the past, inversions in the KC/Chicago wheat spread have been followed by the KC wheat reaching a 35-40 cent premium over CBOT wheat.  So if the July KC/Chicago wheat clears the March high we may look to increase the size of the long position.

Conversely, the July spread just fractionally broke the similar lows from November and February.  If the July spread continues to edge lower, it could have a clean shot at a return to the nearest-futures November low of -40 1/4 cents (premium CBOT wheat).  In light of this, we’re going to use a short leash on the July spread.  If we get knocked out, we can simply watch for a setup to reenter.

Trade Strategy:

On the long May KC/Chicago wheat spread that was entered at the equivalent of at -3/4 cents (premium CBOT wheat), roll to the July contracts at the market-on-close on Friday, April 22nd.  Risk the July spread to a two-day close below -13 cents (premium CBOT wheat).

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.