How I Roll Contracts Forward To Pick Up Market Carry Premium

Published on: 09:04AM Sep 16, 2019
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Market Commentary for 9/13/19
 

Corn Ear Counts 
This week the USDA reported the lowest ear counts in the last 7 years.  Interestingly though in each of the last 6 years, final ear counts ultimately were lower than September estimates.



Ear weight estimates, on the other hand, were average compared to the last 6 years.  In 4 of the last 6 years, final ear weights increased into the final January estimate as compared to September projections.  They dropped in 2018 and were the same in 2014.
 
With this information, it seems reasonable that a national yield reduction is possible; however, widespread favorable weather over the last 4 weeks and upcoming good forecasts for the next 2 weeks may mean improved ear weights that offset some ear loss. 
 
Many market participants still think harvested acre estimates could be trimmed by 1-2 million acres. However, it's important to keep in mind that corn exports and ethanol grind have slowed. These demand issues could negate any supply reduction in the coming reports.
 
Bean Pod Weight & Count 
The report showed the highest pod weight in the last 7 years, while having the fewest pods in the field in September since 2013. In the last 6 years, final pod numbers increased from September estimates to the final numbers; however, in 5 out of 6 years pod weight decreased.  So, depending on the difference, there’s still a chance for a yield decrease in January. 
 
China announced they will buy some beans for fall shipment, but the sales represents only 2% of what they usually purchase from the US in a marketing year.  It will be important for China sales to continue over the next 3 months, because this is the time of year that South America is low on beans, and the US has significant supply from harvest.
 
Old crop carryout was also reduced because crush and export pace estimates increased since last month's USDA predictions. With the ½ bushel yield estimate reductions this month, 2019 carryout forecasts decreased significantly compared to 2018.  If a trade deal could be reached and South America has a production issue, beans could find some upside potential.
 
Rolling Futures
Last week I provided an example of how I "rolled" my September futures sales contracts to the December.  I had several questions from readers on these types of trades, so below provides more detail and my "best practices" for rolling futures and capturing market carry.
 
What Does "Rolling Futures" Mean?
It's the process of moving sales on contract months about to expire to a month further out in time.  In last week's example, I rolled my September contract sales to the December.
 
Why Would You Do This?
It allows me to capture market carry as added premium profit.  Market carry is when the price in a later month is higher than the current month.
 
Historically corn usually has market carry, because it encourages farmers to store their corn until it's needed by end users later in the year. It's a low risk opportunity to increase my farm operation's profitability and it’s what nearly all commercial elevators do with their grain and how they turn a profit.
 
How Does It Work?
Using last week's trade detail:
 
I previously sold some of my 2019 corn for a price against the September that I felt was a good value when I placed the trade.  The price I sold is actually irrelevant to the decision or process to roll my futures forward, because in my opinion, once I’ve made a sale, I rarely see a reason to back out of it. When my September contracts were expiring on 8/29/19, September futures were $3.60 and December futures were $3.70.  I then bought back the September futures and immediately sold the December futures.  The 2 trades keep my sales in place in my brokerage account, but I gain a 10-cent profit.  That's why the price of the futures doesn't matter, only the SPREAD difference between the 2 months matters.  
 
Why Don't The Prices Matter?
Since I'm buying and selling at the exact same time, my position stays the same, but I keep the profit between the 2 contract months.  Essentially, I'm following the first rule of business, "buy low and sell high." All I have done is increased my premium to move my sales further out in time. Moving the sales further out provides better basis opportunities in the future.
 
Since I was already short September futures, when I bought back the September futures for $3.60 and sold December futures for $3.70, my sales position remains the same, except for the 10-cent profit added to my position.
 
But I Don’t See That in My Brokerage Account.
That’s why it’s tricky to only use a brokerage account to keep track of market carry profits.  Brokerage accounts don’t include the details of all the trades that make up my final position and how I got where I’m at.  Months from now I may see those December sales in my account and not remember they were only' made to take advantage of market carry.  That’s why I use a spreadsheet to document all of my roll trades.  Detailed records are essential when hedging grain.
 
What If I Don't Like the New Sale Price?
That's a common concern when considering to roll futures, because farmers may think prices will eventually go higher.  However, that’s speculation, which adds risk to a farm operation.  As a hedger, I want to lower my farm’s risk.  That’s why I'm more focused and concerned about the guaranteed added profit I can collect on the trade, rather than hoping prices could go higher in the future, which is uncertain and never guaranteed.
 
In general, most grain elevators buy your grain and then immediately sell the futures to keep themselves perfectly hedged.  Whether or not an elevator agrees with a farmer that prices will go up, they want to minimize risk and speculation.  By just hedging the grain they purchase from a farmer and taking small market carry profits, they can remain profitable with much less risk than holding and hoping for higher prices. 
 
What If I Buy Back the September, But Wait to Sell December When Prices Are Higher?
That's still speculation. Trying to time rolls is risky and can get a farmer into trouble very quickly if the market doesn't go up.  It's important to remember, the market can always go up, down or sideways.  So, placing trades hoping prices go up, means there is a 1 in 3 chance of being successful.  Speculators putting themselves in this type of situation don't have the best odds.
 
Plus, I still have a lot more 2019, 2020 and even the 2021 crop to sell, so I need the market to rally already.  I don't need to double down on a rally, when I can take a small guaranteed profit right now on a trade I have already made.
 
Another Reason for Rolling Future Contracts Forward
When December futures are about to expire in a few months, I'll then roll my futures again to March to capture carry.  Today there is a 12.5 cent market carry between December and March.  If a speculator doesn't sell December at $3.70 as part of the roll, they would need to sell March at $3.825 just to match the price I could likely get when I do my next roll.
 
For me it's not realistic to assume that corn will definitely be above $3.825 on the March futures down the road.  Corn was sideways through spring of last year, and only rallied after there was unprecedented widespread planting delays.  It's easy to say that waiting was the right decision last year, but what if the speculator threw in the towel too early before the late April rally because it looked like prices might not go up? What if the speculator didn’t sell when the corn rallied in June and still sits on unpriced grain from last harvest today? What if an ongoing sideways market happens again like it did after the last 3 harvests, where prices never went above $3.80 for 6-7 months?  This could mean missing out on several chances to pick up guaranteed market carry premium.
 
The Benefits of Taking Small Profits Now
Hedging, and specifically using spreads, is about taking advantage of small profits now, moving forward, and trying to never lose.  Hedging this way isn't necessarily exciting, and can sometimes even seem boring, but that is how the big grain companies got so big, consistent small profits over and over again. 
 
Some farmers may not like this trading approach, and that's ok.  I just prefer minimizing my farm’s operation risk.  This means I may miss out on home runs occasionally, but my chances of striking out are very low. This helps me sleep better at night.  

 

Want to read more by Jon Scheve?  Check out recent articles:

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Jon Scheve
Superior Feed Ingredients, LLC
[email protected]
 
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