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Effective Spread Management Puts You in Control
by Sherry Lorton

FOR MANY PEOPLE, SPREADS are one of the most puzzling aspects of merchandising. They are necessary to the process but not always understood. When it is not clear why, when or how the spread affects the basis transaction, the decision by default is often to just let it happen. This is not a good approach to merchandising. Not only do you lack control, but you miss out on opportunity and, in certain circumstances, add more risk to the basis position. Spreads are just as important to the success of merchandising as buying and selling basis and should be given the same time and attention. When they’re understood and used properly they can bring much control and consistency to a merchandising program.

The Role of Spreads in Merchandising

Spreads play a variety of roles in the merchandising process. In one respect, they are the key indicator of the market’s needs and their movement is a major force in controlling the flow of grain in the marketplace. When there are excess supplies, spreads widen as an incentive for grain to be carried (stored) until a time of greater need. When supplies dwindle and demand increases spreads narrow or invert to encourage grain into the marketplace. As an indicator of the market’s need, the spread structure determines the opportunities of merchandising. Merchants take direction from the structure of the spreads in deciding whether to be long-the-basis or short-the-basis.

Spreads also play an important role in the execution of the basis transaction. It is often necessary to hold basis positions over time to effectively capture basis change and when this happens, the spread is the critical piece that connects the buy and sell basis together. In this process, not just any spread will do. The level of the spread factors into the margin and, having a favorable spread is necessary to achieving a profitable outcome.

Effective Spread Management

Because we rely on spreads in so many ways to structure and capture merchandising opportunities it is important that the decisions that affect their use are not left to chance. Managing spreads is about making conscious decisions about spreading.

Taking charge of the spreading decision is accomplished in large part through a process known as pre-spreading. Pre-spreading enables merchants to lock in an acceptable spread structure prior to entering into a basis position. By doing so, you know you have the appropriate structure in place to carry out your merchandising plans – no surprises! And, in some instances, pre-spreading sets up the opportunity for a basis position that might not otherwise be possible.

Setting proper spreads begins with a determination of what spread fits into the merchandising equation. This will vary depending on the circumstances and type of basis position you are considering. Generally, there are four points involved in making good spreading decisions:

  • Understand the effect the spread has on the basis position and set goals that will support it. For example, wider carries are favorable to long-the-basis positions whereas inverted spreads are more advantageous to short-the-basis. Be aware of the implications of an undesirable spread on the outcome if nothing is done.
  • Understand the proper mechanics for fixing the spread and be clear on how the spread will be used in the execution of the basis transaction. Spreads set or used improperly can create unwanted risk.
  • Have specific objectives for setting the spread but, keep in mind, the point is not to try and predict the best spread – that would be an exercise in futility. The purpose is to gain more control over how the spread affects your basis position so that you can achieve more consistent and expected results.
  • Understand the implications changes in spreads have on the position after the spread is set. Setting the spread does not lock you into a basis position. If anything, it gives you greater flexibility to react to the need and capture opportunity when it comes along.
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