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Futures Spread Trading: The Anatomy of a Classic Corn-Wheat Spread

January 7, 2011 by Leslie Burton| Tips & Strategies

Why do some traders prefer to spread trade versus trading outright futures contracts?

The contracts often selected by the trader may be typically trading parallel to one another giving the trader only the “differential” moves between the two contracts.

One may take any two markets that they observe have differentials between the price movement and take advantage of that spread!

They may be legged in or put on as a spread trade (often with a reduced margin required for the spread).

Often, traders may think that the risk is less than an outright future.  This is a misconception! The spread trades are no less risky than an outright futures position.  In fact, typically, you may watch it closely, but cannot put a stop-loss on a spread position.

While technical entries may be difficult in outright futures, the spreads may move in sync with some fundamental factors that may reoccur at certain times of the year that affect the movement of the markets.

What types of spreads are used in commodity futures spread trading?

Intracommodity Spread or Calendar Spread

The Intracommodity Spread may also be regarded as a Calendar Spread whereby one would take the same commodity and trade two separate months against one another.  An example would be the the Natural Gas spreads where a trader may want to buy a further out month and sell a nearby month reasoning that the demand from the season may create a need to buy the future month as storage may become depleted.  These work well with grain markets as their carrying charges and seasonal tendencies may create that differential between two months.  They may also be used strategically in the meat complex as producers may take their product to market.  There are many more examples to go through, but this is not a report on calendar spreads specifically.

Intermarket Spread

The Intermarket Spread is a spread trade where one commodity may be spread against another from two exchanges.  An example may be where the Kansas City Board of Trade Wheat may be bought and the Chicago Board of Trade Wheat may be sold in consideration of a potential higher demand of a hard red winter wheat as used for breads and pastries as opposed to the soft red winter wheat typically used in cakes.  This particular spread is one that is not able to take advantage of any margin reductions usually.

Commodity Product Spread

Commodity Product Spreads require more than two contracts of commodities to efficiently hedge or fulfill a specific need in the production of raw materials.  Examples may be the Soybean Crush and the Energy Crack Spread.  These are a bit more complicated, so I will defer this subject matter to a later report.

Intercommodity Spread

The Intercommodity Spread is a spread between two different commodities, but in the same delivery month.  Often this spread will set-up according to seasonality or occasionally a harvest supply/demand picture.

The Corn-Wheat Spread

The Intercommodity Spread is our focus for today!  Specifically, we will analyze the merits of the Corn-Wheat Spread going into the 1st and 2nd quarter of 2011.  This is a trade that I have monitored since the 80’s.  I believe that it was first notable in the mid 60’s.  The beauty of taking a classic trade and reviewing the trends and history of the trade saves time in research and previous observations may even save money on potential variances to watch for.  In this particular spread, we note that July may be a strong month for corn as the weather conditions, plantings acreage, export numbers may still be unknown.  The crop is still vulnerable until toward harvest which is in the fall.  On the other hand, the harvest for the soft red winter wheat may be in July, allowing the market to regard the saturation of a harvested crop.  One may look at the months; March, July and September contracts for this particular spread trade and select another, but this is the anatomy of the spread, not to be confused with a trade recommendation.  As a matter of fact, this spread may be reversed at another time of the year.  June may be a time frame to review the Wheat-Corn Spread.  These grains are both feed product and may also be affected by livestock production trends, global supply-demand figures, weather conditions and basis for the farmer.  The wheat is typically a heavier protein cereal, while corn does not vary to the extreme.  In modern times patents on the seeds of varied grains has become big business.  The USDA regulates the delivery, grades and contract size regular for delivery.  The seeds and fertilizers must also endure disease and pests.  There are Government Subsidy programs as well in some cases to control the crops being planted.  In recent times, Africa has been know to lease land for crops to fulfill some of their required grain inventories in countries such as China.

Technically, it is good to pull up a spread chart to monitor the merit of the potential move.  One may select their Indicators to best confirm an entry.

Corn Wheat Spread Chart

Buy 1 ZCZ11; while simultaneously Sell 1 ZWZ11 at market! One may simply subtract the two commodity prices to establish what the spread is trading at.

Note: One must analyze the potential risk suitable for them and monitor this trade closely.  It is suggested to exit the trade immediately once it penetrates the risk parameter.  If profitable, it is suggested also to monitor the trade closely and potentially exit the trade by the 4th of July perhaps.

This may also be transposed into an options trade!

If you are a new trader, it is highly suggested that you work with your broker on the spread trades that you may have interest in.  You must consider the commission and fees in strategizing any trade, but also note the value that a broker may have on the anatomy of a spread trade for you!

Filed Under: Tips & Strategies

About Leslie Burton

“The best client is an informed client!” Leslie’s 32 years in the futures markets has been well spent monitoring the various indicator packages and systems that professional and retail clients use. There certainly is no “Holy Grail,” but there are basic parameters that potentially may warrant a higher probability of success on trades. She places a strong emphasis on a client’s financial goals and applies money management to keep those goals in perspective. Leslie’s personal desire to trade successfully was found in a trading room set up for the floor brokers coming off the CME floors after each trading day. Hand graphed charts were hanging out of their stuffed pockets. These charts were the only the technical guide that these “pit warriors” had in formulating their trades.

BACKGROUND: In 1984 Leslie began to get involved in the commodity markets by attending numerous classes in technical analysis. Then as a registered broker, Leslie attended Market Technicians Association functions. Leslie has been quoted in Concensus Newsletter, written for Inside Futures, Bar Chart, INO, Futures Knowledge, and has given market updates on Tiger Financial News Network and CFRN. She has also conducted webinars for FX Street on Fibonacci and Advanced Technical, and plans to continue sharing trading ideas and strategies through future webinars.

MARKET FOCUS: She primarily focuses on the more liquid markets. Execution is vital to implement strategies according to one’s trading model.

TRADING STRATEGIES: Leslie derives a trading model upon the initial client consultation. The most important part of the brokerage relationship is to be disciplined within the trade model. She uses seasonal guidelines and spread trades to garnish a differential between various commodities or months. She also believes in waiting for the ‘perfect’ scenario before entering the marketplace. In addition, each position has a stop loss strategy with a risk in mind, and trailing stops or timely exits in place upon the culmination of each trade.

RISK/MONEY MANAGEMENT VIEW: Leslie employs stops for outright futures positions. Options spread strategies may also be used, depending on the forecast for the market. Even in quiet, flat markets butterfly spreads may be used to take advantage of a small range of trading.

TECHNICAL AND/OR FUNDAMENTAL FOCUS: Leslie concentrates on technical analysis, primarily breaking down charts by using various moving averages, parabolic SAR, momentum, stochastics and RSI indicators. She reads and listens to any fundamental factors that may impact the markets. Market psychology is another factor that Leslie includes in her analysis.

Risk Disclosure

STRATEGIES USING COMBINATIONS OF POSITIONS, SUCH AS SPREAD AND STRADDLE POSITIONS MAY BE AS RISKY AS TAKING A SIMPLE LONG OR SHORT POSITION.

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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