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SPREADS ARE REGULATORS Spreads are one of the main keys to hedging rice. Spreads are the tool the market uses to indicate the supply and distribute the selling over a period of time. Spreads are the tool the market uses to discourage the selling in the nearby contract when there is an adequate supply and to encourage selling when supplies are tight. So I guess you could say spreads are the markets tool to either retain supply or not retain supply. The key to profiting from spreads is rolling them from one month to the next at full carry. The result of this is that you increase your net selling price. I will give some examples. Most farmers want to sell cash rice for a Jan-Feb deliveries based on a relationship to the March futures. So the goal is to have your March futures sold as high as possible, but to do this it is very rare that selling March futures is the best way to achieve this goal. Selling the first new crop month of Sep is usually the best trade. Below is an example of a situation that will occur. The numbers are a simplified example, but is a true example of how this spread system works.September 9.00 November 9.15 January 9.30 March 9.45 As you can see the difference between each month is 15 cents cwt per month. Sep starts at 9.00 cwt and a target month of March is 9.45 cwt. A typical situation here is that we will be able to roll our spreads at 30 cents cwt per month. Now on to how the mechanics of rolling works. The initial sell is in the Sep. In late August, just before deliveries against the Sep the Sep-Nov spread will widen to 30 cents cwt. If the initial sell of Sep was 9.00 cwt and the spread is 30 cents cwt the new net price of Nov is now 9.30 cwt as apposed to 9.15 cwt in our first example. This gives a profit of 15 cents cwt. What is happening here is simply selling something and buying back later and then reselling at a higher price. Below I will show the end results and you can compare it to the original situation. First: September 9.00 November 9.15 January 9.30 March 9.45 Second: September 9.00 November 9.30 January 9.60 March 9.90 The above mechanics of going from Sep to Nov is repeated until your short position is now in the March futures. In the first example March was 45 cents cwt over Sep. After the rolls March is 90 cents over Sep for a profit of 45 cents cwt. The next step is to find the best basis and sell your cash rice and at the same time buy back your March futures and you have just completed a Hedge. To give the above a little different perspective lets relate the two future prices back to a cash rice price. I will use a basis of -90 cents cwt under the futures. In the first example 9.45 - 90 cents equals 8.55 cwt FOB or 3.85 bu. Using the rolling strategy you are 9.90 - 90 cents equal 9.00 cwt FOB or 4.05 bu for a profit of 20 cents bu. Now lets look at the current situation and see how this projects for 2007 rice. Currently Jan or March of 2007 is not trading in the new crop so I have to make a couple of assumptions. I will assume that Jan is 15 cents cwt over Nov and March is 15 cents cwt over Jan. If so the structure would look like this. September 10.30 November 10.22 January 10.37 March 10.52 If March was trading and March was sold at 10.52 - 90 cents cwt equal 9.62 cwt or 4.33 bu FOB. Not a bad price, but look what happens when Sep is sold first and is rolled to March at full carry. September 10.30 November 10.60 January 10.90 March 11.20 March 11.20 - 10.52 equal a 72 cents cwt profit or in bushel terms based on a 90 cents cwt under basis equal a 33 cents bu profit by selling and rolling. The reason this years situation is more profitable than normal is due to the fact that Sep is currently at premium of 8 cents cwt to Nov. This is due to the potential acreage cut. As I stated at the beginning when the market perceives a tight supply spreads narrow. This one has narrowed to the point that Sep is actually higher than the Nov. As we get to the late summer months of 2007 it is very likely that due to the very slow export pace there will be a ample supply of rice and Sep will be discounted and trade below Nov. In this situation the nearby on the Sep will trade at a big enough discount to the Nov that it is profitable to carry rice in storage from Sep to Nov. The spreads doing their job in regulating the amount of rice being sold at any one time.
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