September Corn vs. December Corn is a trade we have been involved in every year since 2011 in Turner’s Take. In certain years we have even referred to it as our “bread and butter” trade. I have already received a few emails and calls about it. We are going to give this one a pass this year unless the spread can rally a nickel or dime in the next month or two. So why write about it? I think knowing what trades not to take can be as important as which ones to get into, and I think you should know how to recognize these potential pitfalls too. The Sept/Dec bear spread could be a winner this year but the risk is probably too much compared to the potential reward. If you are a spread trader (fundamental, technical, seasonal, or a combination of all three like I am), there are certain basics you should know that can keep you out of trouble.
So why do I think the risk/reward in Sept vs Dec Corn is not worth it this year? When it comes to bear spreads in any grain contract, you have to know what the full carry is for that spread. In most cases “full carry” is the best price you can get for a bear spread. “Carry” is the cost to store grain per month.
Cost of Carry = Storage + Interest + Insurance
It costs roughly 5 cents per bushel to store corn. So to store corn from September to December, that is 3 months. 3 months X 5 cents per bushel = 15 cents. So full carry for Sept vs Dec Corn is going to be around 15 cents, give or take a penny. Therefore, one would expect that if Sept vs Dec Corn was trading around full carry that the spread would be trading at -15 cents (Sept trading 15 cents LOWER than Dec). For example, if corn was at full carry and Sept corn was $4.00, then Dec would be $4.15, with the only difference between the two contracts being the Cost of Carry (15 cents).
In years past we liked it when Sept was either trading at the same price as Dec or higher, known as “trading at an inverse”. In those years we liked the bear spreading (long Dec, Short Sept). This year the spread is at a 10 cent carry (-10 cents). That means Dec is already trading 10 cents higher than Sept. The best we could reasonably hope for the Sept/Dec spread to move 5 cents lower (from -10 cents carry to -15 cents carry). Five cents is probably the best reward we could hope for in the Sept vs Dec bear spread this year at current prices.
In theory the risk to the upside (remember we are bear spread) is unlimited, but if we have some moderate crop issues the risk is probably to parity (10 cents) while is we have a major crop issue that leads to massive acres and yield loss you can see this spread trade 20, 30 or 40 cents higher from current levels. The probability the sept/dec corn spread going that high is very unlikely, but it is a small possibility that is determined by Mother Nature. The odds we have a normal crop year is much higher, but the reward is only 5 cents. So you have to ask yourself, is the 5 cents worth the risk of a 10, 15, or 20 cent loss (or more) if we have severe drought (though a low probability)? In my opinion, the odds are the Sept vs Dec corn spread is a small winner this year, but just not worth the risk, even if the risk of a major weather event destroying crops is the lower percentage possibility. If we do get a weather scare and the spread goes to parity ($0.00), that is a time when we would reconsider bear spreading depending on the condition of the crop and expected year end carryout figures.
Finally, when you are trading commodities like Grains, Livestock, Energy, and Softs, many of those markets have cost of carry levels where bear spreads typically do not trade beyond. It is important to know those levels, understand when you are in a bear spread, and then have the ability to recognize the risk/reward based on the current year set up and the cost of carry. This is something I try to do in Turner’s Take Daily and for trading clients who have futures account with me at Daniels Trading.
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