Trading futures spreads is serious business for some or a frivolous hobby for others as many are lured by the appeal of lower margin requirements and what they perceive as a less risky way of playing the futures markets. However, saying trading spreads is safer than trading futures outright is a little like saying M-80s are safer than dynamite; you can still get your you-know-what blown off if you’re not careful.
Having given fair warning, here are two spreads that are likely to have popular appeal this summer. The first is the long side of August/November soybeans. So far in 2015, the August contract traded as high as 40 1/4 cents above the November contract and as low as just 7 3/4 cents above the November contract, seen just last week.
As of Monday, the August soybean contract closed 12 3/4 cents above the November and, if El Nino continues to keep temperatures mild in the Midwest this summer, the premium for August is likely to go back up as bearish pressures mount for new-crop soybeans. This may sound odd to some as going long the August/November spread is normally considered a bull spread, but the current outlook for soybean prices is bearish.
Much of this spread’s potential is due to unusually active commercial demand we are seeing in old-crop soybeans. Exports are running ahead of USDA’s estimated pace and NOPA’s monthly soybean crush is running at a record high pace. The most bearish aspects about soybeans in 2015 — record plantings and generally favorable weather — will likely weigh more on the November contract as the season progresses, especially if USDA’s acreage report on June 30 shows more than 84.6 million acres, as many expect.
One risk to this spread could come from a sudden increase in producer selling. Another risk could come from a surprising drop in demand. While neither seems too likely, they are possibilities to consider.
The other spread worth watching this summer is long December corn and short November soybeans. This inter-commodity spread is a little trickier because, as of Monday, the value of the November soybean contract was 2.44 times greater than the December corn contract. For discussion purposes, we will refer to the soybean/corn ratio as the price and allow others to decide whether they would trade 5 corn contracts for every 2 soybean contracts or just go 2:1 corn-to-soybeans.
So far in 2015, the soybean/corn ratio has traded as low as 2.27:1 and as high as 2.53:1. As mentioned above, the current ratio is 2.46:1 and I expect that to go lower by fall, especially if weather stays favorable. By buying corn and selling soybeans, one is taking advantage of the difference in the current fundamental outlooks based on USDA’s new-crop estimates.
For corn, USDA is expecting U.S. ending stocks to decline from 1.85 billion to 1.75 billion bushels in 2015-16, based on 13.63 billion bushels of production this fall. For soybeans, USDA is expecting U.S. ending stocks to rise from 350 million to 500 million bushels in 2015-16 — a more bearish estimate that will go even higher if more soybean acres are added in USDA’s June 30 acreage report.
Corn and soybean prices have both started the 2015 growing season under bearish pressure as planting is ahead of schedule and early weather has been generally favorable. Corn will need rain in June or July and soybeans will need rain in August, but for the most part, if weather is good for one, it will tend to be good for the other. The main difference this year will be in planted acres and it is not likely that new-crop soybean prices have fallen enough yet to reflect this year’s increase in soy plantings.
Like all outlooks for futures markets, expectations can change and surprises do happen, so it will be interesting to see how these spreads actually work out. If you do happen to trade spreads, my advice is similar as for M-80s:
- Make sure you fully understand the margin requirements before you jump in.
- Don’t confuse margin requirements with potential risk. Spreads can be volatile and the risk of futures spreads is larger than the margin requirement.
- Prepare an exit strategy before you begin and stick to it.
If you’re looking for a summer spread that’s a sure winner, I suggest peanut butter. Then again, that is not suitable for everyone either.