Tasty Futures: Corn and Soybeans
Mar 23, 2018
Spring is here, and the agricultural niche of the global financial markets is starting to rev its engine.
This has been illustrated quite clearly through the price charts of soybeans and corn, which have both rallied nicely in recent weeks.
If you're getting excited about the warmer weather and looking for some new trading ideas, a recent episode of Closing the Gap - Futures Edition is worth a few moments of your time.
The focus of the show is the agricultural planting season, and a sample pairs trade involving soybean and corn futures. Whether you're a veteran in agricultural futures, or new to the space, the spread outlined on this show may help improve your overall understanding of the futures market.
The catalyst behind this particular trade idea relates to recent price movement in both soybeans and corn. As you can see in the chart below, prices in both agricultural commodities have been trending upward:
An interesting dynamic in agricultural futures is that contract months with deeper liquidity can often be linked to planting and harvesting. This makes sense, because farmers are looking to hedge their crops during months in which these activities are taking place.
As discussed on the show, the highest volume contract months for corn and soybeans are usually May, July, and November/December. The bulk of these two crops are grown in the northern and southern hemispheres of the Americas, which encompasses spring/summer in each respective area.
As with most products, pricing in agricultural commodities hinges on supply and demand - and the supply side is impacted by how much is planted and how much is harvested. Weather is an important factor, as poor growing conditions can lead to weak harvests (i.e. lower than expected global supplies).
Keeping all of the above in mind, the hosts of Closing the Gap introduce a sample pairs trade involving soybeans and corn. An important aspect of this trade is the positive correlation that exists between the two. While the degree of correlation has varied over time, the two products have a long history of moving in the same direction, to a relatively high degree.
Because the soybeans contract is worth roughly twice the corn contract, this particular spread is structured in 1 by 2 fashion. That means that for every soybeans contract traded, two corn contracts are traded - which helps to balance delta exposure on both legs of the trade.
Given the current prices of both soybeans and corn, the sample trade presented on the show involves selling 1 soybeans contract in favor of purchasing 2 corn contracts. One reason for this particular approach is that gains in the price of soybeans have outpaced corn in recent months.
As you can see in the chart below, the price of soybeans is significantly richer than corn (2 x corn) as compared to the last couple years of data:
Per the above, the current difference between a single soybeans contract and two corn contracts is about $230 - the higher end of the range observed in recent years, which has been roughly $50 to $230.
At the time the show was aired, one soybeans contract was priced around $1,040 while a single corn contract was priced roughly $405, which yields the $230 number ($1,040 - ($405 x 2) = $230).
Traders deploying this trade would be betting on a decline in the price of soybeans, an increase in the price of corn, or both - effectively a narrowing of the spread. It should be noted that because of the listed futures contract months, this particular trade involves getting short soybeans in November, versus getting long corn in December.
Another important point to highlight is that each contract represents 5,000 bushels, which means a trader has gone short 5,000 bushels of soybeans, versus going long 10,000 bushels of corn.
We hope you'll take the time to review the complete episode of Closing the Gap - Futures Edition when your schedule allows. While this particular trade structure may not suit your current risk profile or outlook, it might be beneficial to "mock trade" (paper trade) this spread so that you can observe how it performs over time.
Mock trading is a great way to acquire experience in new products without the risk of potential losses.
If you want to learn more about agricultural futures, we also recommend reviewing a previous blog post focusing on this very subject.
Should you have any outstanding questions on futures, don't hesitate to leave a message in the space below, or send us a message at email@example.com.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
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