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Key words: Intercommodity spreads, Corn crush spread, Ethanol spread, Distillers dried grains, Soybean crush, GPM, Cattle crush, Hog crush
Agricultural Spreads

Spread trading is used on agricultural commodity market as a vehicle to hedge or speculate with futures contracts.

Historically, agricultural futures were used as instruments to hedge against volatile price movements. However, the number of participants increased as well as technology gave fast access to the market. While hedgers transfer their risks, speculators can assume substantial risk or moderate amount of risk by betting on price relationships of futures contracts, namely spread trading. Spreads assume lower risks than outright long or short positions.

Crack, Frac and Spark spreads were discussed in the previous articles. Now we cover agricultural spreads such as crush spreads. There are also spreads between different commodity underlyings like Corn/Wheat, Corn/Soybean, Corn/Oat etc., but the purpose of the article is commodity product spreads where we purchase and sale raw materials as well as derived processed products.

The crush spread is an intercommodity spread that involves spread trading with simultaneous purchase and sale of two or more highly correlated assets.

Grain market

Corn crush

Converting corn to ethanol and increased use of ethanol in gasoline made the prices of these commodities highly correlated. As I wrote in the article Crack spread, gasoline is the product of raw oil; therefore oil prices are highly correlated with gasoline as well.

Historical relative prices

Ethanol spread or corn crush spread is the process of converting corn into ethanol. The spread is very cyclical due to many fundamentals factors.

Corn and ethanol are traded in different units, corn is priced in the US cents/bushel, whereas ethanol is priced US dollars per gallon. In order to calculate the spread, a conversion of prices into equal units is required. One bushel is approximately 2.8 gallons of ethanol. There is also one component that is the product of corn crush, namely distillers dried grains (DDGs). DDGs are traded in the US dollars per short ton (includes 2 000 lbs) and the conversion factor is 0.0085 (17 / 2 000), whereas 1 corn bushel gives 17 lbs of DDGs.

Corn Crush (Ethanol) spread = 2.8*Ethanol ($/gallon) + 0.0085*DDGs ($/short ton) – Corn ($/bushel)

For simplicity reasons, we will not take into account DDGs in our calculation.

Taking into account the formula above, we define the margin:
Crush profit margin = Ethanol – Corn/2.8.
The margin is critical to understanding ethanol industry profits.

Soybean crush

Soybean crush spread is an intercommodity spread in which soybean futures are bought and soybean oil and meal futures sold.

The sale of soybean futures and the simultaneous purchase of soybean oil and meal futures are referred as a reverse crush spread.

Futures specifications are:

Soybeans = 5 000 bushels per contract, $/bushel

Soybean Oil = 60 000 lbs. per contract which is 30 tons, cents/lbs.

Soybean Meal = 100 ton per contract, $/ton

One bushel of Soybeans = 11 lbs. of Oil + 44 lbs. of Meal + 4 lbs. of Hulls.

Hulls can be retained thus it is 48 lbs. of meal that can be produced out of one bushel of Soybeans.

Crush or Gross processing margin (GPM) per bushel is calculated using conversion factors:

Crush spread = 0.022 * Soybean Meal ($/short ton) + 11 * Soybean Oil (cents/lbs.) – Soybeans ($/bu.)

Soybean meal conversion is calculated by dividing 44/2000 which is equal 0.022 tons in one lb.
GPM and processing expenses are used to gauge the total costs of production.

We trade in terms of number of futures and need to calculate the corresponding ratios of Soybean versus oil and Meal contracts. It is easy to see that 1:1:1 ratio will not adequately protect the GPM.

One future of Soybean is equal to 5 000 bushels and yields 55 000 lbs. of oil (11 lbs. per contract * 5 000 bushels) and 110 tons of meal

(44 lbs. per contract * 5 000 / 2 000).

One future of Soybean = 55 000/60 000 of one Oil contract + 110/100 of one Meal contract.

The perfect hedge gives: 60 futures of Soybeans = 55 futures of Oil + 66 futures of Meal.

Meat market

Cattle crush

Cattle crush or cattle feeding spread involves buying Feeder Cattle futures and Corn and selling Live Cattle futures.

Similar to Soybean reverse crush, cattle reverse crush involves taking opposite positions in futures to those that a livestock feeder would use.

We see that the greatest use for corn is feed for livestock. Therefore cattle producers should focus on maximizing the cattle price margin and buying corn at the lowest price.

Animal feeding operation (AFO) begins with cattle that weight 600 to 700 lbs. They are transferred to a feedlot to be fed for approximate 200 days until they may gain additional 400 pounds.

Cattle Crush spread = 6* Live Cattle – 3 * Feeder Cattle – 2 * Corn.

In order to know the precise ratio the same calculation as for Soybean futures contracts should be done.

Hog crush

The hog crush has approximately the same meaning as spreads involving Feeder cattle, Corn and Live Cattle. The margin is captured by selling two lean hog futures contracts and buying corn and soybean meal in the appropriate quantities.

Corn crush spread and Soybean crush quotes are available in the Excel file.