Mecardo Analysis - Is Kansas ok?

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By Andrew Whitelaw | Source: CME, Mecardo

Key points

· Chicago wheat tends to trade at a discount to Kansas.

· Chicago is trading at a record high premium to Kansas.

· Probabilities dictate that this spread will return to parity or a discount to Chicago.

In this analysis we look at the Kansas and Chicago wheat futures contracts. In the past Kansas has traded at a premium, but not at present. Is there an opportunity to be had from the change in dynamics?

The two wheat contracts in the US are the Chicago soft red winter (SRW) wheat contract and the Kansas hard red winter (HRW) wheat contract. These are two distinct contracts with differing specifications, the SRW is low protein (9.5%) whereas the HRW is mid protein (11%).

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Typically, the Chicago contract will trade at close to or a discount to HRW (figure 1) due to it being a higher quality wheat. Recent months has seen the Kansas contract move from a premium to a discount to Chicago.

The spread between HRW and SRW since 1980 is shown in figure 2 as a monthly average. As we can see Chicago very rarely trades at a premium. On only one occassion, prior to the current premium, has it traded at more than a 10% premium.

Chicago has averaged a record premium of 24% for the month of September 2019. There is always a disclaimer when looking at past spreads and relationships – past performance does not guarantee future results.

In previous times when Chicago traded at a strong premium to Kansas, the correction tended to occur very quickly. Although not a guarantee of results, the past does give an insight into the probabilities.

What does this mean?

It is highly likely that the spread between Kansas and Chicago will narrow back down to normal levels. This may provide an opportunity to gain from the change in spread between the two contracts.

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