Expiring contracts present a danger

Delivery periods unstable In its final days, May contract sees big price swings

If farmers needed an illustration of the dangers of getting caught in an expiring futures contract, the market just gave it to them.


As the May ICE Canada canola futures contract went into its final days, its price left the cash market far behind and rose dangerously into its own realm.


“There’s always the risk of fireworks if somebody is on the wrong side,” said Agri-Trend Marketing adviser Brian Voth of Altona, Man., about the wild behaviour of May canola futures, which began in the last week of April.


“The May contract was a broken contract at that point.”


Broker Errol Anderson of Pro Market Communications had the same view. 


“Big gainers, big losers: that’s the danger of a front month.… A few players are left and some of them are putting the boots to the others.”


A complicated process takes place when futures contracts, which are always tied to specific expiry dates, begin to wind down. Options contracts based off the futures contract expire, triggering possible moves by options players in the futures market.


People who have bought futures contracts can “stand for delivery” on the first notice day, triggering actual, physical deliveries of grain or the purchase and sale of physical grain already in store.


Anyone with open positions can find it hard to close them because most contract users will have closed their own positions and “rolled” to the next contract.


Few players are left and surprising things can occur.


It’s what most in the markets say happened with the May contract, although there are many theories about what actually took place. 


Somebody appears to have aggressively bought long May futures, driving its price far higher than what could be explained by any move in the cash or other contract months.


Until the last week of April, the May contract had held what seemed to be a sensible $5-$10 per tonne discount to the July contract. This provided carry in the market, which rewarded farmers for holding canola on the farm.


However, the May contract then suddenly surged compared to July, reversing the discount into a premium with jolting, wide intraday price swings and heavy volume, while open interest collapsed.


Jon Driedger of FarmLink Marketing Solutions said one danger of expiring futures contracts is that they can seem to be stable and then go wild. 


“There was big carry (between May and July) all year, the fundamentals to justify it, then all of a sudden you’ve got this really wacky spread action,” said Driedger.


Analyst John De Pape of Farmco in Winnipeg said such explosive action unconnected to the cash markets is a “technical delivery market event” and a unique phenomenon created by the remaining long and short position holders of the contract.


“You never really know all the details,” said De Pape.


“It’s just a few players at the end.”


However, he said the situation highlights the danger to market players, especially small ones like farmers, of playing in the markets without professional help.


He uses swap contracts with a major financial firm to avoid those risks. They are futures price-based contracts that are wound up before the futures expiry period dawns.


Driedger said farmers using brokers and advisers usually get calls a week or two before the expiry period appears. It’s a call a farmer should take and heed.


“A good broker is going to keep you out of trouble,” said Driedger.


Some farmers use discount brokerages, but Driedger said those who use futures contracts without broker advice must pay close attention to risks such as the one that hit the May contract to avoid being caught on the wrong foot.


“Online (discount brokerage) is cheap and it’s pretty easy, but unless you’re watching the stuff and you know what you are doing, (there are many risks).”


Analysts and brokers say futures are a generally safe way to hedge risk, but hedgers should always close their positions before the technically challenging expiry period begins.

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  1. Edward on

    People, it is far better to have 400 experts that work specifically on behalf of 70,000 farmers with wins nearly all the time, than the present law of the jungle free for all that has cost the Western Canadian farmers $8 billion dollars and the Western Canadian economy almost $80 billion dollars in the 2013/14 crop year. To state that the present system is dangerous is a very big understatement and probably more related to a form of self centred damage control. None of these parasites are trading currency in multiple importing nations, collectively selling to multiple buyers in up to 70 nations, or collectively setting minimum levels of service agreements with railways or going to court to enforce them long before there is any harm done. They are not collectively organizing ship loading quickly at port with proper grades to maintain good relations with customers and no demurrage charges for farmers or collectively doing anything for the farmers in any real not perceived or simply stated terms. These additional middle men do it all for themselves first and are most interested in having all benchmarks removed so they can claim that they helped you and hoping that it is near impossible to tell that they didn’t. Then again an $8 billion dollar loss in a large crop year is not a good sign that they are of much use. If you can’t sleep at night just drink warm milk. It is much cheaper. Burning half your crop would have in fact, given the out come of a free market been a better marketing plan this year. You have to remember that these are the kind of guys that coined the phrase, “The best remedy for low prices are lower prices”. That is their marketing solution for handling a big crop? Give it away. These guy definitely would not have come close to qualifying for a job at the farmers collective selling agency of pre-2012. If “All” grains were sold thru such a system producers would have not only prevented the $8 billion dollar loss of 2013/14 but would have also added another $2 to $8 billion dollars of purely net income on top of that. How sweet would that be. On the other hand maybe Mr. and Mrs. Gingerbread farmer should move right out to the end of the carnivores nose, because the water and other material is getting pretty deep.

    • Mike Klein on

      The current marketing setup is deeply flawed, pushing market risk for all players onto producers, and that is almost entirely downside market risk. Upside market risk not quite so likely to reach producers.

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