Q: A daily subscriber who is a farmer asked:
Mr. Tyllas could you explain why you want to do the soybean may-july spread maybe I'm missing something #1 If you are trying to capture the carry you would want to buy july because now it is an inverted spread. #2 In the last 2 yrs there has been no carry all months were all about the same Are You under the assumption the farmers are going to increase sbn acres and trying sell july before it's know on the june30 crop acreage report. Or from your experience you see something else?
A: Carryout (actual soybean stocks at the end of this marketing year) was reduced 10% on the latest USDA stocks report to only 185 million bushels. In addition, the USDA has understated March to final soybean demand in the last 2 years by 25 to 35 million bushels. This will force this tight supplied market to carry it forward, and if there is trouble with the weather, or Argentine farmers strike over export taxes, soybeans in the hand will be worth more than soybeans in the future. If that happened, I would look for SK9 soybeans to be trading over $9.00 and the cash soybeans and spot month (nearest futures contract month) would have a premium over the next futures month (July).
This has been already seen with the current spread between the March and May contract. The March contract settled on Friday 3/13/ 09 at $8.82 ½ and the May settled at $8.76 ½. The March contract settled with a premium of $0.06 over the May contract. Last week it was trading at a premium of $0.13, and a week before first notice day it was $0.02 under the May.
In May 2008, for my fund account, I traded many spread contracts buying the May and selling the July. I was buying the May for $0.05 under the July, and sold some at $0.05 over. This spread trade idea should not go past the August contract, because the September contract is "new crop" deliverable for the producers in the southern states. The November contract is fully "new crop" soybeans, and that changes the tight supply situation. The old crop/new crop spread is a way to play the tight supply situation, but this spread is not as easy to trade as it was before the funds became a real factor.
As you know from being a farmer, when you sell a futures contract instead of just taking it and selling in the cash, there is a basis trade involved. If the basis does not improve, you make delivery, but if you know can get $0.10 to $0.20 more for the cash than the futures, you can buy back your futures contract and sell your soybeans in the cash. With tight farmer holding the last 6 months, this spread has been gaining more premium.
Having traded when I was on the trading floor, tens of thousands contracts involving a carry charge spread, I am no stranger to this spread. Without looking, I did hundreds last year for my fund account, I remember having 55 spreads on at once.
Bottom Line: Since I feel the supplies will come down below the 185 projected carryout, and farmers will remain unwilling to sell below $9, I think this spread will continue to stay strong. On Friday, the July contract settled $0.01 ¼ under the May contract. If I can sell the July contract $.05 over the May, I would do so. This is a carry charge market, and should be roughly $.18 full carry. This is a known risk strategy if you buy the May and sell the July.
Lastly, I know you being a farmer, until the last few years watching soybeans in many a surplus situation, and watching spreads at 85% of full carry. I consider less than 200 million bushels a very tight situation. I remember 30 years ago there were analysts that said 200 million bushels were needed to fill the pipeline. When the front month gains on the back, it usually reflects a tight situation, and when it widens, a surplus situation that you pay more to store.
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