Scheve: How To Roll Futures And Profit On Market Carry
Feb 12, 2018
Market Commentary for 2/9/18
The USDA report this week didn't affect the markets much. Corn exports were up a little, while bean exports were down slightly. The South American bean crop looks average, with Brazil likely having above average yields and Argentina likely below average.
Next question - How many corn and bean acres will US farmers plant in 2018? Many suspect beans will finally dethrone corn for the most acres planted. Regardless of acres planted, summer weather will have the biggest impact on prices going forward.
How To Roll Futures to Capture Market Carry
Recently a farmer asked how I "roll" my futures to capture carry and what that looks like in my hedge account. Following provides an example of how this is done using real prices from the past few months.
Questions I will answer more specifically:
How does the transaction in my hedge account take place?
How did I get paid?
How do I account for profits/losses on each trade?
How does all of this affect my bottom line?
Example Of How To Capture Market Carry
Let's say a farmer sold corn last summer for $4.15 against Dec futures. Let’s assume that the farmer could have just priced with a local end-user on that same day at a -.15 basis level for harvest delivery. Basically they could have sold for a $4 cash price for harvest delivery. But this farmer has home storage and wants to make additional profit. To do this, I suggest selling the futures in a hedge account, so the farmer can still pick up market carry premium and upside basis potential.
11/29/17 was the last trading day for Dec futures before the CBOT's delivery period, so market participants usually exit their Dec positions before this date. In order to capture carry and "roll the Dec sale forward," the farmer would have to BUY back the Dec futures they previously sold for $4.15. On 11/29/17 the price was $3.39 Dec futures, so the farmer would BUY corn futures in the hedge account for this price. Then the farmer SELLS March futures at $3.535, the price on 11/29/17, to maintain their sold position in their hedge account. The Dec BUY and the March SELL are done at exactly the same time to avoid any price shift risk.
After the farmer simultaneously buys back the Dec futures and sells the March futures, they have picked up 14.5 cents of market carry ($3.535 Mar Sold Futures - $3.39 Bought Dec Futures = 14.5 cents) and have rolled the sale forward to March futures. To put this in the simplest of business terms, the farmer bought Dec low (at $3.39) and sold March high (at 3.535). That spread of 14.5 cents is the profit in this part of the trade. The previously sold futures of $4.15 is NOT a factor in calculating market carry at all. Market carry is just the premium that will be added to the $4.15 original sold futures price.
Example Of How To Capture Basis
Then let's say a farmer likes the basis level being offered by an end user (say -.05) today (2/9/18). That is a 10 cent improvement in basis (-15 at harvest to -5 today). To capture basis, the farmer will physically SELL their grain to an end user and price the grain with the end user off of the March board price (today it's $3.65). Then at the same time the farmer must BUY the same amount of futures back in their hedge account for $3.65 against Mar futures that they just sold the end user.
Now the cash contract with the end user is $3.60 ($3.65 futures less the -.05 basis). This will be the amount of money on the check from the end user.
Wait - The Farmer Could Have Originally Sold Cash For $4 With Harvest Delivery (Above)
The farmer will actually receive more than $4 when adding the end user check AND the money in their hedge account. Following is the math:
Dec Futures Sold: $4.15
Dec Futures Bought: $3.39
Profit from Trade: $ .76
March Futures Sold: $3.535
March Futures Bought: $3.65
Loss from Trade: -$ .115
Profit From Trade #1: $ .76
Loss From Trade: #2: -$.115
Net Gain In Hedge Account: $ .645
Cash Price From End User: $3.60
Hedge Profits: $.645
Final Cash Value: $4.245
The farmer received $.245 profit, which was derived from Market Carry (14.5 cents) and Basis Improvement (10 cents) to hold the grain from harvest until today.
The above figuring is complicated, so I always think in terms of the following instead when planning my trades:
Original Futures Sale: $4.15
Market Carry (Spread Profits):$ .145
Basis Level on Day Sold: -$.05
Final Cash Value: $4.245
Common Mistakes I See Farmers Make When Trying To Capture Carry And Basis
Failure To Keep Detailed Records
Often farmers will see they sold March futures for $3.535 in their hedge account statements, then when they sell the cash grain, and have to buy those futures back, they think they are losing in their hedge account. They'll forget why they sold the $3.535 at any point because the statement doesn't show the reason. Usually they are left wondering why they would ever have sold corn for that price.
That's why it is so important that farmers keep meticulous records of EVERY trade. Missing one trade or misunderstanding why you did something can lead to speculative (aka risky) positions. Sometimes farmers think they'll remember what they did, but I can assure you that few can.
Trying To Time The Market
Sometimes when farmers "roll" their futures from Dec to March they'll try to time the market by waiting an hour or day, which could turn into a week, to make the second trade instead of doing it simultaneously as I recommend. When farmers do this they are doing nothing but speculating and adding unneeded risk to their farm operation and profits. To be clear, that isn't hedging. And while it may work occasionally, it is far from guaranteed. The added risk is unnecessary and unadvisable. The same can be said of the trade to the end user and when buying the futures back in the hedge account. I don’t ever try to the time the market as I don’t want to speculate.
I recommend to farmers that if they want to speculate, open a different account and speculate in that. It's easier to see at the end of the year if you made money or not. Don't turn a hedge account into a spec account because it’s too difficult to keep spec trades separate of hedge trades. This can lead to not only will your profits be uncertain, but your banker will likely be very unhappy with you.
Operating a hedge accounts seems complicated but after time it becomes second nature. During times of low prices, farmers need to be doing everything they can to increase their profits and minimize risk, even if it means it takes a little extra paperwork sometimes.
Superior Feed Ingredients, LLC
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