Suppose that you are the risk manager for a ethanol plant. For your plant, corn is the raw product, and ethanol and DDGs (distiller’s dry grain) are the products of the corn crushing process. Assume the normal yield of crushing from 1 bushel of corn is 2.8 gallons of ethanol and 17 pounds of DDGs. The current futures prices for corn, ethanol and DDGs are PC ($/bushel), PE ($/gallon) and PDDG ($/short ton), respectively, and cost of crushing is C ($/bushel).
(1) Write down the equation for the locked-in profit in terms of product prices and cost.
(2) Given the current futures prices: Corn: $7/bushel, Ethanol: $2.6/gallon and DDGs: $120/ton, calculate the corn crush spread.
(3) Describe spread trading strategies that take advantage of abnormal corn crush spread levels.