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Contract spreading grows

Agriculture.com Staff 04/16/2012 @ 1:16pm

Commodity spread trading is not for the faint of heart. It has long been held as a specialists market but as of late has come more into play as another way to express bullish or bearish sentiment with less margin money. That is not to say they are less risky but the participating futures exchanges will give you credit for owning one against another.

Traditionally the price difference between two deliverable months has had to incorporate the cost of carrying the commodity which is made up of insurance on stored commodity, storage costs and interest rates payments for the capital needed to own and store the commodity.

When the nearer month (spot) is priced lower than the further out month we call this contango and this is the normal price pattern and expectation in the market for the simple reason of the above storage, insurance and interest rate payments.

The opposite effect is called backwardation and occurs at times of short term stresses in the market as well as ‘one off’ events.

The above chart is the July/Dec corn spread going back to last April 2011. As you can see, the volatility of the spread can be just like that of a single underlying contract. Over the last year you can see that the spread has traded as low as 24.75 and as high as 126.5. Over a dollar move from high to low in a year is a good example of actually how much these spreads can move. What this spread represents is old crop vs. new crop and whether or not we have a good supply of corn in the pipeline. If the weather has been good and we have planted a lot of corn acres but we don’t have enough corn in the short term for our needs you may see that spread move back towards our highs of 126.5. If our short term needs are suddenly met but the weather has taken a turn for the worse you may even see that spread trade below zero where we have a contango situation which would be the normal scenario. This spread is a very popular vehicle as it pits our short term needs against the crop in the ground.

Another popular spread is the spread of this year’s crop vs. next year’s crop. Let’s take a look at Dec12/Dec13. 

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