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530 USD on corn: Detailed analysis of my trade

4 Jul 2018,

A single corn trade brought me a beautiful $ 530. It is really a good result for a conservative bear spread. You have been asking me how I managed this position, so I decided to describe my approach to it in this article.

 

 

 

Name of the bear spread ZCN19-ZCZ18 tells us that it is a spread within one harvest (July – December of the previous year). It is common that within one corn harvest, market is in contango. In other words, this is the normal state of the market where more distant contracts are traded at a higher price than the closer ones. There are several reasons. The main one is the storage cost, which is reflected in the price of the futures contract. Of course, the more distant the contract is, the higher is the storage cost are and the higher are the prices. The fact that the contango is common within one harvest is also proven by the average curves of the term structure for the last 5 and 15 years.

The corn market is generally situated most of the time in the contango, which you can clearly see on the contango histogram chart. At first glance, it is visible that the largest area of ​​columns lies in the positive contango (negative area means backwardation). We can also help ourselves with the table at the top left where we can find the percentage expression of the contango frequency, in this case over the last 5 years. I do not think there is anything else to be add to such high percentages.

Analysis of storage costs

It is therefore quite clear why it is worth to trade bear spread on corn. Such an environment is just made for this strategy. But of course, that is not everything. Another important part of my puzzle is the analysis of storage costs. Specifically, I mean a graph where I see a ratio of spread to full carry over the last few years. You can see this analysis in the following chart. Vertical lines point to my entry into the position.

You must have noticed that the blue curve, which represents the current year, was at the bottom of the normal range. This suggests that spread was simply cheap and therefore potentially profitable. In addition, there was also a growing trend in the following period. As a conservative level of the first profit target, I selected 50% full carry at that time.

COT analysis

Commitments of Traders data also plays a very important role in my trading system. This analysis seemed relatively favorable for the strategy, mainly on the side of the hedgers. Rather fast, they began to increase their hedge positions. I also looked at the fact that the COT index still had space for higher rates. Thus, there has been a space for higher corn prices. On the following graphs, the arrows point to the COT index during the first entry into the position.

Technical analysis

As far as the technical analysis is concerned, the price was on the resistance at the time of my entry with the first part of my position. Still, I also counted with the scenario where corn growth will continue. Spread Report customers know that I did not exclude a breakout of over $ 4. And that finally happened. The following chart shows the price of the July contract and the arrow points to the entry with the first part of my position.

 

Spread price development

Now let’s look at the price of the spread as well as my entry and exit strategy. Entries are indicated by green line and exits are red. At the price of 16.25 cents, I entered with two contracts in February and I entered at 14.25 cents with a single contract in March.

Why did I enter the trade when all the analyzes were not perfect? In this type of trade, one important thing must be concerned – it does not usually have a very favorable RRR (risk-benefit ratio). Therefore, waiting for the most favorable conditions could mean even worse resulting RRR or even missed entry. Best strategy, at least from my experience, is therefore to enter at corrections. However, of course, we cannot accurately estimate the end of the correction, and that is why risk management is particularly important. It is necessary to consider the possible continuation of the correction, and therefore the opportunity to enter at a better price. Therefore, my strategy is usually not to enter with the whole position to the first correction, but to keep some “ammunition” for later.

 

I was betting on contango and a very positive full carry analysis. And as you can see from the chart, the trade eventually evolved according to my expectation. With one contract, I exited on the breakeven. The reason was an increasing risk. The closer we are to the summer, the greater the impact of weather on crop and hence on increased risk. The price of corn at that time was close to resistance and we could not exclude possibility of break up.

 

Exit from the position

But the trade has developed favorably. Finally, I did not wait with the exit to the originally set 50% of the full carry. I had good reasons:

– First of all, we were approaching the risky summer season

– spread has reached resistance on 22c

– the price of corn was in the area of ​​support

– COT was no longer so favorable

– spread rose to above 45% of full carry (close to 50% target)

 

As you can see, there were many reasons, and so I stepped out of my position. The trade brought me a decent $ 530, which is a very good result for a bear spread. Maybe you think the profit could have been even higher if I did not get out with a single contract earlier. You are right. But have we seen the right side of the chart at that time? Unfortunately, no. The situation on the market could have turned to my defeat. For example, unfavorable weather could cause a rally on the corn, as well as a sharp drop in the spread. Reducing the risk is never harmful and at the right time it made more sense than to hold the whole position at any cost.

 

A very informative article was also written by Pavel Hála, who is behind SpreadCharts.com. I highly recommend reading this article because it also explains the fundamental reasons for trading corn.

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