Joe Ross' Spread Scan Newsletter

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Spread Scan Issue: February 14, 2007 - Volume 131

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Otherwise, welcome to this week’s issue of the
Joe Ross Spread Trading Newsletter.

Each week we present spread trading examples and opportunities in order to help you become a more professional spread trader.

Spread Scan Example:

This week we look at BOK7 – BOZ7.

Today we consider an intra-market bean oil spread: long May 07 Soybean oil and short December 07 Soybean oil (BOK7 – BOZ7). The spread has been going sideways since a strong down move in December 2006. The down trend seems to be broken. Normally the spread has a seasonal up-move in February (approx. 2/1 – 2/10) and gives us a possible 1-2-3 low for an entry.

Traders may want to enter the spread at a value of –1.30. Margin for the spread is $135 (reduced margin). Suggested risk is $120. Initial projected objective is $120, then a move to –0.60 or higher. Basis is seasonal and a 1-2-3 low.

Previous Trades:

Andy Jordan's Trading Bites

Student's Question: "Andy, can you tell us a bit more about carrying charges and how to calculate them?"

Andy: Carrying charges are the cost of storing, insuring, and financing a commodity over time. In futures, they limit the premium of deferred delivery over a more nearby contract. If it were otherwise one could, for example, simultaneously buy March and sell July futures, take delivery of cheaper wheat in March, store it, and then redeliver more expensive wheat in July - all for a risk-free profit.

Here is what the CBOT tells us about Carrying Charges:

“Information concerning carrying charges, deliveries, receipts & storage costs for CBOT listed products can be found in each product’s corresponding chapter in the About CBOT section.”

So far so good, but how to calculate carrying charges?

Maximum storage rates are set by the exchange. The CBOT sets the maximum for wheat at 0.015 cents/bushel/day, or 4.5 cents/bushel for a 30-day month. Insurance is nearly negligible, and is usually included as a part of storage. Financing costs are normally calculated with the price of the nearby contract at the prime rate plus 1.00%. For example: March Wheat is at about $4.63/bushel, and the prime rate at 8.25% per year (remember to divide the yearly cost for the amount of actual time elapsed), the cost to finance is about 3.57 cents/bushel/month. Thus, total carrying charge for one month (storage plus finance) is about 8.07 cents/bushel/month. For example, full carry from March to July (4 month) would then be about 32.25 cents/bushel.

Most spreads never go to fully carry because the commercials borrow money at rates below the published prime rate. The practical expectation would be approximately 80% of full carry for the widest point a particular spread may go. In our example above, the practical expectation for our March – July Wheat spread would be about 25.80 cents/bushel.