5,000 Bushels of Corn on your Lawn

The comment that will never die when having a conversation with people unfamiliar with managed futures and commodities trading is something along the lines of, “So, you ever get a truck full of Corn delivered to your house?”

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The short answer is ‘no’, we’ve never had a truck full of Corn delivered – to our house, office, or anywhere in between. You see, while futures contracts were originally designed as a way to purchase or sell future deliveries of commodities like Corn, these days very few deliveries are actually made, and less and less futures contracts are settled with physical delivery. Can you imagine coming home from work one day, and having 10,000 bushels of corn unloaded in your front yard? (2 Contracts * 5,000 bushels per contract).

The main idea behind a futures contract like Corn is that a farmer can lock in the price today that he will sell his Corn not coming out of the ground until next fall. That allows Mr. Farmer to do things like budget for new equipment, fertilizer, and so forth. He knows his acres, and already knows what price he’ll earn, effectively hedging away his market risk. But the only way that really works is if the person who agreed to pay the price today, receives what he pays for in the future. So, at the end of each commodity futures contract, the seller of the contract (the farmer) has to make delivery of 5,000 bushels of Corn, 1000 Barrels of Oil, 100 troy ounces of Gold,  to the buyer of the contract (through the exchange).

So any of the people who buy one of the 100,000+ Corn futures contracts traded on an average day are going to get 5,000 bushels delivered to their house?  No… Look closely above and see we said ‘at the end of each commodity futures contract’.

And here’s where most people get confused. You see, it is utterly foreign to most people to understand that commodity futures contracts have a finite life. So while the CME (formerly the CBOT) offers the overall Corn Futures contract – you don’t actually trade the Corn Futures, you have to trade a specific ‘contract month’ such as December 2013, July 2014, or May 2015. The December 2013 Corn futures contract, for example, was first traded on in Jan 2010  – and expires on 12/13/13. After that day, you can no longer trade that contract. If you still want to be ‘long’ Corn futures after that date, you have to exit the Dec. 2013 and enter a new contract which expires at a later day.

So, it’s only the people who hold their futures contract til delivery who are set to get a truck full of Corn dumped on their front yard (which is all myth, by the way, the delivery actually has to be done to one of the CME’s registered grain elevators).

But before any such deliveries take place, the buyer will be warned with a “First Notice Day,” in which they will be warned that if they do not exit the expiring contract, there will be 5,000 bushels of corn heading their way with no other option than to hold their own corn festival to attempt to get ride out it all. Then comes the “Last Delivery Date,” in which at the end of trading day, the buyer must cash settle or accept the physical delivery. In the case of corn, the CME lists the First Notice Day as, “The business day prior to the 15th calendar day of the contract month,” and delivery date as, “Second business day following the last trading day of the delivery month.”

Today, the bulk of the industry is speculators (that includes you, managed futures investor) and not farmers, and those speculators rarely hold a futures contract to delivery. The more normal course of action is to trade in and out of the contract up until a few weeks before it expires (holding it much longer/closer to expiration opens you up to some very illiquid moves as the volume all moves to the so called ‘front month’ contract).

As for managed futures – the CTAs running the various managed futures programs take care of all this for you, the investor – monitoring any positions they are in and “rolling” those positions as the contracts near ‘first notice day’.  And as we’ve talked about in a recent newsletter – this rolling of positions can add a cost to trading commodity futures called the roll yield.

So next time someone asks whether you’ve ever had a truck of Corn delivered to your house when they hear you are invested in futures markets – tell them…

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