Old Advice for Current Times
I first heard this maxim about 25 years ago, and it wasn't new then. The person who shared it with me learned from an experienced basis trader who probably had heard it from someone else before that.
Like many great principles, it is an oversimplification. Like many simple things, it requires a solid understanding of other principles. Like any proverb that gets passed down instead of forgotten, it's supremely useful advice.
Easy to Grasp, Hard to Follow
It's easy advice to understand but often difficult to follow. This is especially true when the payoff is just to stop a bad situation from getting worse - and this is the scenario many are facing right now.
We're wired to optimism (which often translates to waiting for things to get better) and regret avoidance (which often translates to doing nothing, so we don't have to regret a decision later).
Get Out of the Nearby
Grain businesses are most commonly short nearby futures, so let's focus there. The best thing that can happen to a short nearby futures position that will be rolled to a deferred month is for the spread to that month to be a carry greater than the cost of holding the grain. The worst thing that can happen is for the spread to be a huge inversion. Everything else is just a matter of degree.
If spreads haven't built carry by the time harvest is over, and the crop size is pretty well known, they aren't likely to do so in any big way. The opportunity for greater carry or less inverse is minimal - the potential for larger inversions is unknown but real and will cause great pain if it happens.
Nearby futures are the location of greatest risk for short futures, unless you can sell the grain early.
Sherry Lorton : Jan 27, 2015