Corn: A Hair's Breadth From $8

Continued rain in the soaked Midwest grain-growing regions of the United States continues to put additional upward pressure on corn and other grain prices. Corn is just one penny shy of $8 on the December '08 contract (the most liquid). Soybeans prices are also less than 50 cents from new all-time record high prices on the November '08 contract. The grain bull is running again!

Crude Oil Strikes $142

$142.26 and counting...

Stock Market Rout

The Dow closed down 358 points today in a second large rout this month. The first occurred when the unemployment rate increased .5% in a single month, sending the Dow down more than 400 points. This certainly doesn't bode well for the stock markets or economic prospects in the United States. This is not only a new low for the Dow for 2008; it is also a new closing low prices for the year.

Crude Oil Blasts Through $140 Price

Limit UP for Corn

The Fed's Cred Is Dead!

With stocks down more than 200 points, and commodity markets moving significantly higher across the board today, the Federal Reserve's credibility at fighting inflation is rapidly waning, if not already dead. The Dow today has set a new low for the year 2008, and sentiment is poor. Even with economic data released today that was fairly good, stock index futures sunk even lower. Despite the similarity to the 15 minute chart above, this second chart (below) is the daily one for the Dow. It reveals the true gravity of the situation.
Nearly every commodity chart today, from crude oil to corn, is substantially higher following what is now perceived as yesterday's weak Fed inflation-fighting statement. This last screen capture shows the daily chart for the broad-based Rogers Commodity TRAKRS futures, which reached a new all-time high price today.

OPEC: Oil to Reach $170 This Summer!

If the OPEC ministers genuinely believe that the price of crude oil is being driving higher by speculators, who better to use their limitless trillions of Dollars of oil wealth to short the market and teach the speculators a lesson by forcing prices down? Perhaps the conviction of OPEC oil ministers isn't as sincere as they would have us all think! Prices have risen today, and have reached just $1.40 off record highs from the past two weeks.

Today, OPEC may have revealed its true belief when OPEC chief Chalib Khelil tipped his hand and said that he expects the price of crude oil to reach $170/barrel this summer. Hey, it's summer now, Mr. Khelil!

Meet the World's Biggest Oil Speculator

Yes, the world's biggest short bet that crude oil prices will fall is Fed Chairman Ben Bernanke. Based upon the Fed's statement yesterday at the close of the FOMC meeting, crude oil and other commodity prices should soon start to moderate, and perhaps fall. The financial markets perceived the statement as being weak on the Fed's commitment to fighting inflation. The statement was perceived similarly by both commodities and stock markets, causing stock market index futures to fall, and inciting a reaction of higher prices across the board in the commodity markets.

If this morning's follow-through of prices in both arenas is any indicator, the Bernanke Fed has made a bad bet. They shorted oil, and prices moved higher, with stocks moving sharply lower in reaction.

Stocks Uncertain of Fed Statement

The stock indexes, after trading erratically for an hour following today's Fed statement, have begun to sell of. There was much debate over the meaning and weight of the Fed's statement. Stock index futures were higher throughout the trading session until the Fed statement. It remains to be seen if the stock index futures will hold onto some of the day's gains from earlier in the session. It appears that the bears are in the driver's seat for the moment, and that the stock market didn't care for the Fed's statement. Many traders received the impression that the Fed will be somewhat weak on fighting inflation for the short- to medium-term future.

My long treasury futures trade has been amplified, as investors are fleeing into treasury futures. Go treasuries!

Grains Surge Higher on Early Fed Statement Release

The Fed released its statement early, before the grain markets closed today. This caused all the grain prices to explode higher in the closing minutes before the market closed. This soybean chart shows the market reaction following the early Fed statement.

Other commodity prices moved higher also. Both gold and crude oil recovered somewhat off of an otherwise down day.

Waiting On the Fed

Many futures today are in a stagnant waiting mode for the Fed statement to be released at 2:15 pm EST this afternoon. Volatility should be vigorous following that.

The grains have been fairly active today, but without huge moves in either direction. Since the Fed decision is released at the same time that grains trading closes for the day session, the impact will likely be felt first this evening.

I have been trading primarily treasuries and soybeans today. Good day for both. Treasuries, for some reason, trade more sedately than most other futures. I like them because they tend to more more smoothly and gradually, and I can place larger trades because of the smaller margin requirements. Treasuries (I trade the 10-year) are my favorite futures vehicle to trade after soybeans. I also like treasures because, since they tend to move more slowly than other futures, I can monitor and day trade other futures at the same time.

Stocks Swell as Crude Oil Swoons

The stock market index futures have risen upon the weekly release of the EIA crude oil inventory numbers that indicated a larger-than-expected rise in crude oil inventories. Crude oil has sold off forcefully, dropping nearly $5 a barrel on the news. Needless to say from these two charts, they are directly correlated.

S&P 500

Crude Oil

New Writers on this Blog

Today, readers here on this blog may have noticed that a new writer appeared with an article. Rick Dawson is a futures broker and friend of mine, and he has submitted an article on spread trading for the benefit of (me and other) interested readers.

I admit that I know nothing about spread trading. I am planning to educate myself more so that I can take advantage of spreads to increase my own trading profits. Anyone who would like more information can contact Rick by clicking on the links in his article.

I have no affiliation or financial connection of any kind to Rick's firm, Common Sense Capital. I receive no remuneration or referral fees from him, either. I just wanted to have him write so that I could learn, and in so doing, perhaps benefit other people also.

Other writers may also appear on this blog from time to time also. If you or someone you know would like to submit an article, feel free to contact me.

I hope regular readers will enjoy Rick's article. Good stuff!

Futures Spread Trading: Controlling Risk - Creating Opportunities

Futures Spread Trading

by Rick Dawson

Introduction

Futures spread trading has always been a popular method of trading futures. However, many beginning traders focus exclusively on buying and selling futures outright. Spread trading is the preferred approach for many professional traders. By adding spread trading, traders can increase their opportunities and better manage their risk.

This article will focus on futures spreads instead of options spreads. A futures spread is the purchase and sell of futures contracts in related markets. (A spread is also created when a trader or hedger takes a futures position opposite an existing or potential cash or physical position. However, this type of trading – basis trading - is outside the scope of this article.) The two positions must have an economic relationship to qualify as a spread.

Futures may be spread between different:

1. Points of time. This is also known as a calendar spread. The same commodity is bought and sold in different months. An example of this would be an old crop / new crop grain spread where you're short July corn and long December corn. If you're short the nearby month it's called a bear spread. If you're long the nearby month it's called a bull spread.

2. Commodities. An example of this would be a long December corn / short December wheat spread. I would also include spreads between a commodity and its products in this category, such a soybeans versus soymeal and bean oil (crush spread) and crude oil versus gasoline and heating oil (crack spread).

3. Markets. An example of this would be a long September Minneapolis / short July Kansas City wheat spread. In this example, you're long spring wheat which trades on the Minneapolis grain exchange and short hard red winter wheat which trades on the Kansas City board of trade. (Note that September is the first new crop month in spring wheat whereas July is the first new crop month in winter wheat.)

Note that a spread may fit in different categories. For example, a spread between December Minneapolis wheat and May Chicago wheat would different markets and points of time. A spread may not easily fit in a specific category. For example, is a spread between 10-year and two-year notes a commodity spread because two commodities are involved or is it a calendar spread because it's really a trade involving interest rates at two different points of time? It really doesn't matter as long as there is an economic relationship between the two contracts. In other words, a spread created via a correlation study between orange juice and pork bellies doesn't qualify as a spread. Correlation is not causation.

Why Trade Spreads?

The components of “legs” of a spread tend to move together. This makes sense when one considers the fact that if there's an economic relationship between the two legs then the same market forces will push both up and down. The implication of this that when you spread trade you give up a certain amount of opportunity. But the compensating factors still make spreads an attractive trading approach.

Cons:

1. A certain amount of opportunity is lost

2. A stop order isn't available on except with a broker willing to take the order – probably on a “not held” basis.

3. Commission costs may be greater because multiple contracts are involved.

Pros:

1. Usually less volatile than an outright long or short position

2. Tend to have lower margin requirements

3. More amenable to fundamental analysis

4. Good trading vehicle for positional trading

5. Offer additional “trending opportunities”

I would like to focus on the last benefit of spread trading. Speculation wisdom usually emphasizes the importance of trading with a trend. The problem is that futures markets tend to spend a lot of time in consolidation or trading ranges. It's interesting in note that two markets may not show a pronounced trend but if you spread one against the other then a trend will emerge. For example, if you had sold July '08 cotton on the close of 20 March 2008 at 73.83 and covered on 29 April 2008 on the close at 69.25 would have gained 323 ticks for a $1615 profit on futures contract with an initial margin requirement of $2520. (See the chart below.) However, during this time July cotton had a high of 82.23 for a potential loss of $4200. If you're honest with yourself, would you have stayed in this trade? Probably not. And even if you did, would the stress and frustration been worth it? Most traders would not think so. A chart of December '08 cotton shows a similar story.

(please click on chart to open up larger version in separate window.)

However, once you spread December Cotton long against July Cotton short a much more tradeable trend emerges. On March 20^th and April 29^th this spread closed at 5.45 and 8.45 respectively for a 300 tick gain or $1500 on a spread with an initial margin requirement of only $420. Consider the chart below. Any trader would admit that this trade would be been a lot less stressful for a gain not much different than an outright short would have been.

(please click on chart to open up larger version in separate window.)

Conclusion

The components or “legs” of a spread tend to move together. This makes sense when one considers the fact that if there's an economic relationship between the two legs then the same market forces will push both up and down. Spreads tend to underperform strongly trending markets. However, markets tend to spend a lot time in consolidation ranges during with times spreads can offer more trends and opportunities.

Rick Dawson is a registered Commodities Broker with Common Sense Capital. See the website for contact information. Trade ideas and setups are available at the Pattern Report. There is a risk of loss in futures, options, and spread trading.

Here is a link to Common Sense Capital's website.

Grain Prices Collapse on Profit-Taking

USDA data yesterday afternoon showed no strong impetus for higher grain prices, leading to profit-taking today. This chart shows corn on the left, and soybeans on the right. I have exited all my long trades for grains. I expect grain prices to remain relatively well-supported, but am open to shorts going forward. Today is an example. Even wheat has reversed and prices are now flat for the day. In a tight trading range environment like this one, swing trading is my specialty. I will take both long and short positions alternately.

Generally, I trade only on a short-term basis (day trading). However, over the past few weeks, a very strong bullish trend was under way in the grain markets, so I took some longer-term positions, which I have now liquidated.

I have begun opening additional futures accounts with other brokers. This way, I can trade long-term chart with one broker while trading short-term (day trading) with another. Why would I do this? Because I can take short-term profits within a longer-term trend.

Wheat Sharply Higher

Not very often does wheat lead the way in the grain complex, but such is the case today for the first trade of the day.

Crude Creeps Higher, Unconvinced!

While I personally don't trade crude oil futures (or haven't so far this year), I was disappointed that last weekend's summit in Jeddah, Saudi Arabia, didn't result in anything but rhetoric. Apparently, today's crude oil futures market feels the same way, since prices are moving higher, and are within $2 of the all-time high price. This is remarkable, considering that the July contract expired just last Friday.