Market Matters Blog

CME Leaves Current SRW Wheat VSR Rates Unchanged

Mary Kennedy
By  Mary Kennedy , DTN Basis Analyst
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The Feb. 22 DTN National SRW Index chart determines current futures prices, cash prices and basis levels as to how they relate to seasonal tendencies. The Index is a national cash average determined from cash bids compiled by DTN on a daily basis. (DTN chart)

On Feb. 22, the CME released an update on the variable storage rate (VSR) mechanism in Chicago Board of Trade (CBOT) SRW wheat futures after examining nearby calendar spreads to determine adjustments in maximum contract premium (storage) charges.

"The March 2016-May 2016 wheat calendar spread averaged 43.56% of financial full carry during the period of Dec. 21, 2015, through Feb. 19, 2016. Although this result is below 50% of financial full carry and would normally trigger a reduction in maximum wheat premium charges, the current premium charge is already at the minimum allowed by the mechanism. Thus, the maximum premium charge that a wheat regular delivery facility may charge holders of its outstanding shipping certificates will not change from the current maximum charge of 16.5/100s of one cent per bushel per day (approximately 5 cents per bushel per month)," CME said in a news release.

The VSR mechanism was introduced in November 2009 to improve cash-futures convergence at futures contract expiration, after failing to do so nearly a year and half prior to that. Farmer and grain merchants were concerned that commodity markets had become more volatile due to increased speculation from funds. A large percentage of commercial market participants told the CME that the VSR concept "would transfer a large portion of the price discovery process, currently occurring in the basis, to the futures spread market, and result in improved cash-futures convergence."

The CME explains that the basic idea behind VSR is to "trigger higher storage costs that allow wider spreads when spreads are near financial full carry and trigger lower storage costs when spreads are narrow or inverted. Research conducted by CME Group staff and the University of Illinois indicates that the wheat market often exhibits poor cash-futures convergence when wheat stocks are large and calendar spreads are 80% to 100% of financial full carry. However, convergence tends to be excellent when stocks are smaller and calendar spreads are less than 80% of financial full carry. The VSR will continually expand financial full carry until calendar spreads fall below 80% of financial full carry."…


Futures market convergence is the process where cash market prices and futures market prices come together, or converge, at futures market expiration. The CME notes that, "Theoretically, convergence occurs at every futures contract expiration because of arbitrage; if cash prices remain below futures prices, a market participant could buy in the cash market and sell in the futures market, and make a risk-free profit. Similarly, if the cash price is above the futures price, a market participant could buy in the futures market, take delivery and sell in the cash market, again earning a risk free-profit."

Fred Seamon, associate director of CME Group commodity research and product development, wrote that "Convergence issues arose following a bountiful harvest and a constrained wheat futures delivery system. CME Group acted, through collaboration with all categories of market participants, to address these delivery market constraints, and the results so far are quite promising as convergence occurred in the Chicago delivery location with the expiration of the March 2010 futures contract. CME Group will continue to monitor convergence in the wheat contract and work closely with our customers to assure the CBOT Wheat futures market is a well-functioning contract that provides the world with price discovery, price transparency, and effective price risk management tools."

Dan Maltby, consultant for Risk Management Group, told DTN that, "Theoretically, in times of plenty ... storage charges would be wide, or even very wide, or wider ... a very cheap basis would allow wider storage charges, and theoretically "convergence" would happen ... and the futures delivery mechanism would 'work'..."

Maltby added, "Keep in mind... KCBT (owned by CBOT, which is owned by CME) uses a 'seasonal storage rate' (9 cents/month for 5 months... etc.) and MGEX does not fluctuate their storage at all. The main goal of CFTC and the exchanges, theoretically, is to help convergence."

The VSR tool has come under attack by opponents who feel that it would distort the market. A thesis published by Kansas State University in 2011 showed the importance of continued data collection, informed observation of basis trends and market conditions, and "well-developed empirical models and associated hypothesis testing will help alleviate modeling problems and provide answers to the effectiveness of VSR or other tools designed to bring about improved cash-futures convergence for Chicago wheat and other wheat futures exchanges."

Currently, the SRW contract is the only CME contract affected by the VSR. In 2014 there was chatter that the CME was looking at introducing VSR for corn, but the CME has yet to do so amid strong opposition from market participants.

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