For years, the Chicago SRW Wheat contract has been the contract of choice to use as a hedging mechanism not only for US producers, but also international producers, mainly as a reflection of increased liquidity. However, since the CME Group acquired the Kansas City Board of Trade, volumes in the KC Hard Red Winter Wheat contract have been trending upward, and the spread markets have become considerably more liquid over the past few years. Ample stocks, coupled with the stability of the market have allowed more volume to transact on a daily basis, allowing hedgers to utilize and roll their HRW shorts via the KC HRW contract, rather than depending on the Chicago SRW contract due to liquidity concerns.
The KC HRW contract represents trading opportunities for both hedgers and speculators alike. The US produces significantly more HRW than SRW; the latest WASDE report illustrates the large discrepancy in the size of not only production of SRW vs HRW, but also exports, and total domestic use.
|U.S. Wheat by Class: Supply and Use|
|Year beginning June 1||Hard Red Winter||Hard Red Spring||Soft Red Winter|
|2015/16 (Est.)||Beginning Stocks||294||212||154|
|Supply, Total 3/||1,130||828||531|
|Ending Stocks, Total||446||272||157|
|2016/17 (Proj.)||Beginning Stocks||446||272||157|
|Supply, Total 3/||1,532||800||542|
|Ending Stocks, Total||Mar||566||189||221|
With good supplies on hand over the past few years, despite a quality premium in HRW vs SRW, KC HRW wheat prices have briefly dipped below the SRW values. This has historically been a rare occurrence, and as evidenced in the chart, and the quality premium has e-nsured that this type of relationship is generally short lived. An advantage of the KC HRW Wheat contract is that it is deliverable via its own contract specifications, or against the Chicago SRW contract at a slight discount. Although the KC HRW contract represents a higher quality wheat, market forces can cause momentary disruptions to the premiums normally afforded to the KC HRW wheat, and the flexibility in the delivery mechanism allows commercial participants to take advantage of those disruptions. This type of delivery – KC HRW against a Chicago SRW futures position – has happened a few times over the last year specifically to take advantage of this pricing discrepancy.
The CME Group provides an exchange-supported implied spread to trade the HRW/SRW spread and thus, the technological needs of those who wish to trade this spread have decreased significantly. The chart below illustrates the inability of this spread to hold carry values over the long term, both in the Mar as well as the May spread. As can be seen below, the Mar Inter-Contract spread spent only brief spells below the even money level, and recovered nicely each time it did spend time there. The May spread also briefly dipped below the even money mark and rebounded rather quickly. Moves in to a carry is something to keep an eye out for in future contracts, and could provide good opportunities.
Over the past few delivery cycles, the KC spreads have only been able to move about a penny or so wider than storage, despite good stocks on hand. As seen below, this played out with the Mar-May, with a storage rate of around 12, the spread was able to trade as wide as 14, but only immediately prior to First Notice Day.
With many of the spreads in the curve already trading rather wide, some only a few ticks away from storage only levels, there may be good opportunities for spread ownership deep into the curve. As an example, both Sep17-Dec17 as well as Dec17-Mar18 are both trading within only a few cents of storage levels. With the harvest still a month off, and good global demand starting to show up for US HRW, these spreads could present some good opportunities. It seems unlikely that these spreads will trade much wider than storage only levels as very few KC spreads have done so in the past prior to becoming the lead spread. Based on historical tendencies, Dec17-Mar18 specifically seems to offer good opportunities for bull spreaders, but could require some patience.
Please keep in mind, as with all trading, past performance is not indicative of future results.
The views and opinions expressed herein are the opinions of the individual authors and may not reflect the opinion of CME Group or its affiliates.
David Durra is a professional spread trader, and former analyst at AgSpread Analytics. He has been a member of the CBOT since 2008 and has been trading full time since then.