- 2000: Volume 9, No. 2 A Bullish Opportunity in CRB Index Futures

For those traders looking to diversify their investment portfolio, it may be time to look at the CRB Futures Price Index futures contracts traded on the New York Board of Trade. More and more large investment professionals, and individual traders alike, are focusing on this popular index. Whether it is from inflation fears, worldwide political uneasiness, or reallocating some profits taken from a sizzling stock market, commodity investments are beginning to attract increased attention.

The oldest and most widely followed commodity index, the CRB Futures Price Index, is currently trading at levels which are very attractive for commodity bulls. In 1999, the CRB traded down to price levels last seen in 1975. The 1999 intraday CRB low of 182.67 was reached in July, setting up what technical analysts call a "double bottom" when compared to the intraday low of 182.76 reached in February 1999. This powerful technical formation has historically proven extremely reliable in forecasting important market turning points. It appears likely that the deflationary cycle, which has been influencing commodity prices since 1980, has run its course. The 15 percent rally in the CRB since the July 1999 low provides further evidence that commodity prices have indeed bottomed.

CRB futures are the preferred vehicle for investing in commodities. They insulate the investor from having to choose one, two, or more individual commodities for investment by providing a basket of 17 different commodities in one single product. As with all products, the more you know the better your ability to trade it effectively. This is more applicable to the CRB than almost any other index you are likely to trade. But if one takes the time and the effort to understand the subtleties of this index, the rewards can be substantial.

The CRB is based on a six-month window of 17 commodity futures contracts. The CRB Futures Price cash index, which is disseminated over the ticker, is a calculation that comprises the immediate six-month window of commodity prices. However, the listed futures contract is calculated using the six-month window beginning with that listed CRB contract month. While the differences between cash and futures are always quite small it pays to be aware of why the differential exists. Two things occur during the life of a CRB futures contract. First, component commodity futures contracts will be removed from the Index when they are in delivery, or when they expire, whichever comes first. Second, on the day after a particular contract is removed, a new contract is generally added into the index, usually the contract that is five or six months out. This deletion and addition of differently priced component contracts is why you may see the CRB cash value move significantly from the daily close to the next day's opening, before any of its underlying component futures contracts have opened for trading.

If that sounds complicated, believe me when I say it isn't. It is, however, something to be aware of because it influences the price of the CRB cash value. And the advantage goes to the trader that knows what adjustments are going to be made to the Index. There is a formula for determining the "fair value" of the listed CRB futures contract at any given time. The "fair value" takes into account the adjustments that will be made to the cash index between now and contract expiration. CRB calculates the "fair value" for each listed futures contract and disseminates these values in real-time over its data products and services.

Knowing the fair value is not essential to successfully trading CRB futures contracts, but it can help when trying to properly evaluate trading strategies involving the CRB. Being able to identify at what level the CRB futures are trading versus their fair value may allow a trader to enter the market with a competitive edge. A short-term trader may notice that CRB futures are trading at an unusually large discount to CRB cash with only a short period of time until expiration. Buying at the discounted level may allow the trader to make a nice profit on only a slight upward move in the cash index while also providing a small cushion on the downside. That cushion almost always makes holding a position a little easier.

The CRB Futures Price Index is geometrically weighted. While an in-depth discussion of what this means mathematically is beyond the scope of this article, the bottom line is that the listed futures contracts almost always trade at a discount to their fair value. The farther out you go, the larger the discount should be. For the long-term bull, this allows an entrance to the market at a reasonable discount and the ability to roll that position at a continuous discount from one CRB futures contract month to a more deferred contract month. This is possible because the arbitrageurs are willing to sell CRB futures at a discount in order to hold on to their offsetting positions in the Index's component commodities. For the long side trader, this means continually realizing the discount level transacted at. Even though the deferred months may trade at a price premium to the CRB, they almost always trade at a discount to their fair values.

CRB futures contracts are settled on a cash basis. This means that at contract expiration, either side, longs or shorts, can simply let their CRB futures contract positions automatically settle against the CRB cash index. There is no need to close out a position if not desired.

CRB makes available on its Web site, www.crbtrader.com, a tremendous amount of information about the CRB Futures Price Index. Over the coming months the web site will provide information on many aspects of the CRB Index including fair value quotations and related trading strategies. Articles, informative tables, charts, and arbitrage strategies will all be detailed. Those willing to get to know the nuances of the CRB Index may find it was time very profitably spent.

For information on trading futures and futures options on the CRB Futures Price Index visit the New York Board of Trade web site at www.ICE.com.

Raymond T. Murphy is president of RTM Management, Inc. (RTMM), a commodity trading advisory company. RTMM specializes in developing commodity allocation strategies for investment professionals. Office phone: 203-792-1100; Email address: rtmmgmt@aol.com