Old Crop Versus New Crop
Seasonally speaking, this is the time of year when you see a lot of new crop versus old crop spreads in the grain markets. If you are new to the futures arena then you are probably confused as to why farther out contracts are trading for less than current contracts.(backwardation). You would think that carrying costs would create upward pressure on farther out contracts, if you are selling futures covered by stored supply.(contango).
Why is it counter-intuitive?
In order to understand why this is, you first you need to understand the difference between old crop and new crop. The grain markets all follow a regular cycle of planting and harvest, which happens regardless of market conditions at the time.
Planting Months (old crop supply from previous season)
Harvest Months (new crop supply comes to market)
When the new crop is harvested, there is once again an abundance of supply. Subsequently late in the year is when many of the grain markets post their lowest prices of the season. (see grain market seasonality chart below)
The 2012 drought has left 2013 supplies in a interesting position, while the markets are off their drought highs, they are still elevated.
Given the current shortage in supply, it is safe to assume that farmers will be planting corn, wheat and soybeans on every square foot of soil they can find. Therefore when the harvest does finally come, if there is good weather, supply should come to the market.
As the grain traders in the pits like to say, “supply happens”.
Let’s take a look at the product curve for Corn Futures (ZC).
As you can see the ‘old crop’ supply is priced significantly higher than farther out months. This is because the expectation is that there will be ample planting and ample supply from that planting.
Historically, grains have seen greater supply after drought years since data has been recorded.
“With Iowa and Illinois still dry from the 2012 drought and relatively high corn prices, local farmers are considering raising more corn this year.” University of Illinois Corn Specialist Dr. Emerson Nafziger says, that “corn following drought corn usually produces a good crop. With some possible carryover nitrogen, less corn residue, and possibly a little more water storage, corn after drought stressed corn picks up some advantages.”
General Seasonality Guidelines
In general, the months where higher levels of buying occur are:
The months where higher levels of selling occur are:
How does this trade work?
Quite simply you are short July (N) corn, and long Dec (Z) corn. You are in a calendar spread.
Here is a chart showing the DEC-JUL Corn Spread. The benefit of this spread is that you are protected from parallel moves. Corn prices could fall to $2.00 a bushel and as long as JUL & DEC fall at the same rate – JUL would offset DEC and vice versa.
What you are trying to accomplish here is a dip in July prices on ample acreage planting, good weather, and lacking demand to due elevated prices in the near term.
There are 4 scenarios that make $.
- July is flat, Dec rallies.
- July falls, Dec is flat.
- Both fall. July falls faster than Dec, on supply.
- July rallies, but Dec rallies more, on poor fundamental into summer, such as bad weather, drought, disease, ect.
- Both rally or fall equally. Spread does not change into July and July contract expires. (really a BE trade or better, unlikely)
There also 3 losing scenarios.
- July rallies near term, Dec is flat. Spread gets wide.
- July is flat, Dec falls further on supply from good planting, weather, ect.
- July falls but Dec more falls on supply.
For this trade I would be looking for the spread -150 to hold and on test or a rally over -140. Risk from here is around 10 points @ $50 a point ($500), so you have the option to give it some room and risk $750-$1k per spread. You can also wait for a pullback or breakout.
March 25th 2013
Increased acerage of planting and lacking demand both for exports and internal demand pushed corn prices limit down. Near term corn contract prices fell faster than the longer term contracts, hence the DEC-JUL calendar spread reverted to a more sensible spread. Similar moves also happened in Soybeans, and Wheat.
Limit Down for CORN per CME Group: $0.40 per bushel expandable to $0.60 when the market closes at limit bid or limit offer. There shall be no price limits on the current month contract on or after the second business day preceding the first day of the delivery month.