Good Idea Meets Bad Execution

For the past few days I have been highlighting the growing possibility of a rally in grains, particularly wheat, driven by short-covering from trend-followers. And when that rally came today, we got run over. The market hit stops during the first hour that caught us and our Leg-O-Matic Spreader for something like 6-8 cents (24-32 ticks) on both intermarket KC vs. CBOT wheat futures and on calendar spread orders just on the CBOT wheat. Just awful really.

Another complicating aspect was the talk (which I haven't confirmed) that DB's Agriculture ETF would be re-weighting toward KC wheat and away from CBOT wheat due to the effect of the VSR (variable storage rates) pushing CBOT to ever-larger contangos. In the grand scheme of things, DB's move isn't so important--maybe 5,000 of the net 170,000 commodity index wheat longs moving to the KCBT contract; less than 1.5% of the CBOT open interest. But, of course, in the short term, that's big news. May KC wheat jumped to 20 cents over CBOT. And KC wheat outperformed on a day when we would expect the CBOT, which has a much bigger short interest from trend-followers, to have narrowed its discount to KC.

So we daytraded a bunch of intermarket spreads for a loss on a day when the volatility should have enabled us to make some decent margins. The only bright spot may have been that the distant calendar spreads (especially CBOT) continue to go to steeper contangos. We bought July10/ sold July 11 CBOT wheat at over 103 cents;with fully carry on the KC wheat inside of 70 cents, we would like to pick up about 35 cents rolling forward a July KC/ July CBOT intermarket spread. So, with July KC/ CBOT around 15-17 cents premium KC today, we could still develop a position a year forward with July KC at close to 20 cents under CBOT.

It's like an electronic farm: we plant the KC seeds at 20 cents under today, and we harvest them next year at 20 cents over...This is an attractive trade I have discussed previously, with the main concern being mark-to-market in the event that CBOT spreads continue toward super-contango.