Ideas for Trading Wheat
By Joe Vaclavik, MF Global
The wheat market has more than doubled previous all time highs in many contracts and continues to show strength despite the potential for huge global production in ’08. Hard Red Spring wheat, traded at the Minneapolis Grain Exchange, has seen a major shortage and has caused prices to skyrocket in upwards of $19 per bushel as a result. Chicago and Kansas City contracts have followed along; however have not seen the massive explosion in values that has been seen in the MGEX contracts. Before deciding which wheat contract to trade and what position to initiate, traders should be aware of why each specific contract moves and what the differences are between them.
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The following is a quick breakdown of the specifics on each wheat contract:
Soft Red Winter Wheat (Chicago Board of Trade): Grown mainly in Midwestern states. States with the biggest annual production include Illinois, Indiana, Iowa and Ohio. The CBOT contract is the most widely traded among the three. The flour produced from SRW wheat is generally used to make cakes, cookies and pastries. Planted in the fall and harvested in the spring.
Hard Red Winter Wheat (Kansas City Board of Trade): Grown mainly in the plains states including Kansas, Oklahoma, and Texas. This is most heavily produced wheat in the United States. HRW wheat is used in mainly for bread making. Planted in the fall and harvested in the spring.
Hard Red Spring Wheat (Minneapolis Grain Exchange): Grown mainly in the north and northwestern United States. Top producing states include Minnesota, North Dakota, South Dakota, and Montana. It is grown as far west as Washington and Oregon. HRS wheat is used in milling and bread making. HRS generally has the highest protein levels and is most often of higher quality than HRW and SRW wheat. Planted in the spring and harvested in the fall.
The differences between the fundamentals of each contract are obviously what make the price action between the three vary. On any given day, the market will see significant discrepancies in price action among the wheat traded on each exchange.
Now that you’re familiar with each wheat contract, we can move into the current fundamentals of each contract and use them to create trading strategies.
Inter- Market Spread Trade Ideas
Knowing the fundamentals of each wheat contract allows traders to initiate inter-market spread trades. Since volatility in the MGEX contracts has been great due to recent record-high prices, we will focus most of our attention on the KC and Chicago contracts.
Chicago Wheat: Experienced an increase in acreage this fall and will likely see big production in the US and overseas. Demand for SRW wheat has been consistently slower than that of its counterparts over the past several months.
KC Wheat: Actually saw a decrease in acreage this year despite record high prices. Demand continues to flourish partly because of its close relationship to spring wheat and the ability of some millers to blend HRW wheat with HRS wheat.
Using these very basic fundamental factors, we’ve come up with a simple trade that may be effective in these markets:
Buy 1 May KC Wheat
Sell 1 May Chicago Wheat
KWK8/WK8- Daily
May KC wheat is currently trading about 38 cents over May Chicago wheat. We expect the spread to move to 60-70 over at some point over the next few weeks. Traders should look to initiate this spread at the market and risk 20 cents.
Option Trading Ideas
Since Chicago wheat has seen a big jump in acreage this year, we believe that the new-crop July contract may be overpriced from a long term perspective. Therefore, we advise that traders look to purchase PUT options as a means to capitalize on a possible setback.
Buy 1 July Wheat 850 PUT option for about 50 cents
July Wheat - Daily
July Wheat is currently trading about 960. We believe that a move towards the 750-800 area is likely at some point over the next few months. The option has 122 days of time value and provides traders with a fairly large window in which to see a break in the market.
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About Today's Author:
Joe Vaclavik began his career in the brokerage industry working for a prominent ag-marketing firm. He worked primarily with grain and livestock producers in developing cash marketing plans and viable hedging strategies. Now at MF Global, Joe continues to work with a large number of grain and livestock producers across North America and also works with both private and institutional speculative traders. He prides himself on providing traders with his personal research and has worked hard to ensure the success of his clients. Joe authors his Grain Wire every morning which includes a market outlook and trade recommendations. He also issues a weekly Grain Marketing Update which advises producers on cash grain and hedge positions.
Joe can be reached directly at (877) 310-5643 or at jvaclavik@mfglobal.com.
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