Another month has passed, it’s unbelievable we are not approaching the middle of July! This month in the Seasonal Spread Option Strategy we were down -1.08% and the market remains very difficult. During the month we were forced to stop out one of our long term trades. Specifically we were long the Kansas City Wheat against Chicago Wheat. Before I continue, in case you are not familiar with this trade in our strategy, we typically trade on the long side the Kansas City wheat contract because we generally believe the actual Kansas City wheat underlying the futures contract is of better physical quality and thus should be worth more relative to the Chicago wheat (of lesser quality in our opinion) contract. Unfortunately, this year, in this spread, we have not been correct with our assumption. We were stopped out while long as the spread between Kansas City and Chicago wheat touched a new historical low for the July contract forcing us to take losses.
To better demonstrate what has been happening on a historical basis please consider the chart below. What is important to look at in my opinion is the black line which represents the spread (discussed above) year of year.
It is my opinion that this trend should not continue for the long term. Historically I believe our thesis about the KC vs CHI wheat quality for this spread tread to be correct. We are looking for the September spread in this pair of futures contracts to begin making its seasonal low. Our expected time frame and hope is that we may see a price bottoming around or during mid-July. Once it is our opinion the spread has started to bottom out we will look for a good opportunity to get back into this position.
Further pressure to the strategy during the month came from institutional money covering shorts and running out of both Soy as well as Corn contracts. The aforementioned Kansas City vs Chicago Wheat spreads were further impacted by two things; 1) Chicago Wheat is of better quality this year than was expected and 2) the Chicago contract has more volume than the Kansas City contract which can also negatively impact the aforementioned wheat spread strategy as it becomes “unbalanced” with regard to buying and selling pressures.
We have been watching cash prices closely in the US where we observed small price differences than we saw in the futures markets. This is yet another reason we are hopeful the price in the September contract will move more towards its normal levels.
Generally clients have been asking about what is different this year in the strategy? To be direct, as well as simplistic, in the past a larger percentage of our trades were profitable. On average we were able to close 2 to 3 (and sometimes more) trades for a profit every month than we have been able to in 2016. I believe the reason for this is a change in volatility from 2015 to 2016. This has caused our price targets not to be reached, tightening the spread pricing range giving us less room for error. Also as described above we have had abnormal seasonal factors which have impacted market fundamentals differently in 2016 relative to 2015. We are taking less winning trades and the winners that we are taking are not as profitable as they once were. Since the ratio of profitable trades to negative trades has narrowed the strategy performance has suffered.
Going into the late summer and early fall we will continue to refine our model to these differing market conditions. We are having to look for tighter and smaller price ranges within the spreads the strategy looks to trade. In so doing our trading frequency will go up, which will increase transactional costs, however we are hopeful this will provide better opportunity to participate in more profitable positions, improving our overall win to loss ratio, and hopefully offsetting increased transactional fees.
As always if you have any question please do not hesitate to contact us.
Thanks a lot
Thank you for your trust.
— Gregory Placsintar
— Miguel Sanz Castello
THE RISK OF LOSS IN TRADING COMMODITIES CAN BE SUBSTANTIAL. YOU SHOULD, THEREFORE, CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION. THE HIGH DEGREE OF LEVERAGE THAT IS OFTEN OBTAINABLE IN COMMODITY TRADING CAN WORK AGAINST YOU AS WELL AS FOR YOU. THE USE OF LEVERAGE CAN LEAD TO LARGE LOSSES AS WELL AS GAINS. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.