Episode 28: Dennis DeLaughter I: Learning on the Chicago Board of Trade

After farming for forty years in Texas, Dennis DeLaughter sold his stake in the operation to focus solely on grain marketing. He had -- since 1981 -- been intrigued by the math behind market movements, and wanted to work harder on their unpredictability. Now, Dennis has built a grain marketing service for rice farmers, offered through Indigo's managed pricing program, that "talks the risk" in the futures and cash markets every day with sound technical analysis. 

Tune in for more on the strategic blueprint behind Dennis' plan, his time spent on one of the world's oldest stock exchanges, and why he thinks COVID-19 had such an impact on commodity prices. Plus: Why Gabe sees history as a "data point and not a constraint," and advocates for not harping on past market events.

Interested in Dennis’ managed pricing program? Sign up for it here.

TRANSCRIPT

Gabe: We've got Dennis DeLaughter joining us. Dennis, do you want to say hi to the folks?

Dennis DeLaughter: Hello there. Good to be with you guys today.

Gabe: Appreciate you making some time for us. Where are you talking to us from today?

Dennis DeLaughter: I'm in Austin, Texas right now. I had a farming operation down in the Jackson County area for over 40 years, and I have been in the marketing side of it for many years. I'm now just doing marketing from Austin.

Rodney: Dennis, you said you've farmed for 40 years. Rice farmer, I assume?

Dennis DeLaughter: Yes. Yeah. Farmed rice, corn, wheat, and a few years of soy beans, but beans, back in the days when we were actually working with them, it wasn't the best of crops for our particular area because we're extremely in a wet zone. We're just right off the Gulf of Mexico where our farm is at.

Rodney: Yeah, sure. And if you don't mind me asking, how long ago did you pass on the farm or quit farming?

Dennis DeLaughter: I actually sold the farm for our partnership back in '18. We had a partner who died and because of the fact that we had absolutely no interest from any of our family to continue the farming operation and we had everything paid for, so we decided the time to exit was good. And so we sold everything in '18, and I've been doing the marketing full-time since then.

Gabe: And was the marketing something you picked up along the way or was that a deliberate move after selling the farm?

Dennis DeLaughter: Well, my background is not just farming. We owned a grain elevator where we bought corn and milo for years. I became a commodity broker back many years ago. I think I took the test series three in '81. And then in '86 or '87, I had a really good year. I had gone up to Chicago several times. I bought a seat on the MidAm, which is on the Chicago Board of Trade, and then went up there and traded on the floor for 20 years as a floor trader and specializing, of course, in rice.

Gabe: I don't think I've heard anybody say MidAm in at least 10 years.

Dennis DeLaughter: Yeah. Yeah, the gold badge. I never understood that. We had a gold badge and everybody that was a full member had a yellow badge. I always thought the gold badge was better than the yellow, but they said corn was better than gold.

Gabe: So then how much time did you spend in on the board proper with that seat or was that more an investment move than anything else?

Dennis DeLaughter: No, it was actually more ... I had clients that had started to work with me as far as me helping them sell their rice crops and corn and soybeans here along the Gulf Coast. And as I just picked up those clients, it was kind of a weird situation. I kept a daily diary of things, and one of my commodity clients was sitting in the office one day and he saw that I was writing in these notes and he said, "What are you doing there?" And when I told him, he said, "I'll pay for that. If you'll give me that, I will pay for that every day."

Dennis DeLaughter: And that began the process of me starting to put together, and then just by word of mouth, I grew into ... I think back then maybe the most I ever had was maybe 40 or 50 clients, something like that, along that area. And all I was doing is just advising them on market risk and things like that. I like to tell people I'm a risk analyst, but that's really how I got started into it.

Dennis DeLaughter: And then obviously when I got a chance to get onto the floor to trade in the rice, I went up there because you can see things and know things. You call it the trader's edge, the floor trader's edge, because you're seeing who's doing what and how the market's functioning. And so I would go up to Chicago maybe eight to 10, 12 times a year. Had an arrangement with a hotel up there that I could come up and I'd buy a block of rooms for the year and then I would go up and spend a week and then come back and do what I do in Texas. And so I'd do eight to 10 times a year. I would go up there depending on how the market was functioning.

Gabe: How do you feel about ... I don't think it's a secret at this point how little actual action takes place on the floor. Do you see that from a risk management perspective for those people trying to execute stuff, has that been a gain or a loss? And if it makes sense to talk about rice and corn separately, that might be applicable too, but I'm curious what your view is on it having lived through that transition.

Dennis DeLaughter: Well, of course, as a floor trader, you miss the excitement. I obviously miss the adrenaline rush of being there on the floor where capitalism is at its best. I miss that. There is also an advantage because I was not totally dependent upon being on the floor where I was able to be in both worlds. I'm trading from a screen, trading from the floor, and I find that today it's easier to do my job trading just from the screen because I get to see the deck, I mean, what is available for everybody else to see through the matrix systems, so I'm able to see that, and that's what you can see when you're on the floors. You would know where the buying and selling was, who was doing it, was it weak buying or weak selling at what zone, in what area.

Dennis DeLaughter: I guess my answer to that would be I miss the floor. I think every floor trader does. And some of the guys who were totally tied to the floor have to go do something else because the transition from floor to screen is really difficult, but because I was doing both and able to do both, I find my job is easier doing what I'm doing today than what it really was back in the time when I was coming to the floor. But I do miss it.

Rodney: Man, that wasn't the answer I expected, Dennis. Especially in rice, I thought you were going to tell me that that trader's edge was really advantageous back there. We talked to Sean last week about liquidity problems inside of rice. And I fully expected you to say, "I miss seeing the eyes of that guy across the aisle from me." You're saying that technology really did a decent job of replacing that feeling for you. Is that right?

Dennis DeLaughter: Yeah. One of the things you need to know about me is that I am a technician. I follow the lines. I am more into the technical side of the market and what the market is telling me by the trading action than I am by what the fundamentals are I hear or those kinds of things.

Dennis DeLaughter: When we were trading them from the floor, and it is true that when you're trading rice, you do want to be able to see the eyes, but what would happen in the floor is if somebody came in and there was just all of a sudden, you could just feel the change in the market, you could just feel it change, and that is because you would sense that the traders that were there, the locals that traded strictly the rice, you could just sense that there was some type of a change occurring.

Dennis DeLaughter: And that, of course, we've lost. We can't. We don't get that feeling. But being a technician, I'm looking at the trades. I'm looking at the volume in the trades. I'm looking at a period of time. I have multiple systems that are working and telling us where the risk is at, and technical trading is strictly historical. It's one of those things where it says that in the past when this has happened, then usually this has happened. And so it's an historical type situation. I would say that there's definitely been a loss in that regard, but because I wasn't on the floor all the time ... If you talk to a guy who was on the floor all the time. If you talked to the guy who was on the floor all the time and that's what he did, you'll get a different answer. Because I was trading from a screen as well as being on the floor for part of the year, I mean, six, eight weeks out of the 10 weeks at the most sometimes maybe, I would just have to tell you that the world that I'm in now, I prefer just because I'm a technician and I can see what the markets are doing price-wise. One more thing I would tell you is that the volume is way up. We're trading a whole lot more volume than what did with back when I was starting, about to seat in '87, and we were just excited to get to a thousand contracts open interest, and that didn't happen for years. The volume is definitely up and the tool is a little bit better than what it was. There's still some issues, obviously. It is a thinly traded market, but it's a market that I've traded for a long time.

Rodney: Yeah. That's great. I appreciate that. We talked a lot about liquidity issues last week with Sean and I'm sure we'll dive into a little bit about that today. Part of that seemed to me to be due to the fact that a lot of this rice is just traded cash, just cash-driven heavily. I'm curious, how does that feel when you're in Chicago? When you're from Texas, which I think John said was that heavy castrated market, and then you find yourself in Chicago at the Port of Trade, does that feel like a totally different world to you or do those things feel really disconnected?

Dennis DeLaughter: First year, there was a learning curve, but then after that, I mean, I'd walk into the pit and the guys would be like, "Oh, Dennis is here." It became a natural thing. I can't really tell you that I felt a whole lot of difference there, but when I was on the floor, I wasn't next to my computer. As a technician, now I'm strictly running by what's happening here so I have to kind of change my mentality and become more like a local trader there and provide some liquidity in the pit itself, but I didn't have the computer. That was a little bit different, but to be honest with you, I would tell you that I didn't feel a whole lot different when I went up there or if I was back in my office down here in Texas.

Rodney: I guess building off of that, how much connection were you feeling between the actual cash market price action and that futures price action based out of the board? Could you see clear patterns and correlations, or was your activity on the board kind of a more macro attempt at managing risk and taking exposure?

Dennis DeLaughter: Again, it depends. For guys in Texas, there's no connection. It's very hard to connect futures and cash because nobody's putting out a bid based off the futures market. Everything is based off of cash. If you do your homework and you sit on the cash prices and follow them as close as we do, and then compare it to the board, you will find that there is a range of basis levels that the market doesn't want to get out of. They're very wide in Texas. Now, if you're in Arkansas [inaudible 00:11:11] those delivery points in that county area up there in Arkansas, now you're connected to the board much more. A lot of the trading that we do today for our clients in Arkansas is based off of the board, but here in Texas, yeah, it's a complete disconnect.

Rodney: That cash trading in Texas, and I'm sorry to hone in on that. I'm a Midwest guy, Dennis. My family farms up here in Illinois, and I'm just used to the board of trade to manage your business. I'm so intrigued by this cash business. I'm curious, does the cash business in rice in Texas versus Arkansas given advantage to either side? Does either side have a better ability to manage their risk?

Dennis DeLaughter: Okay. The answer to that question is yes, but it may be more from a position standpoint. In other words, guys in Texas, their crops going to come off early. They're going to be in some regards able to pick up some of that year end crop issues. For instance, right now we have a very high basis because our prices here in Texas are running in that 12.50, $13 level, depending on what your grade is. There's a situation in Texas where we get some of the end of the year benefits. It's like, actually we get the same thing in corn and wheat down here. A lot of our corn clients will be able to sell corn based off of the July futures, some in the wheat market were able to definitely sell it off of the May futures.

Dennis DeLaughter: That's kind of old crop when you really look at it from a Chicago board of trade standpoint. There is an advantage from us down here in our seasonality, as far as the along the Texas coast goes. Early buyers or early... Yeah. Early end users can come to the market and that will kind of give us a little bit of a leg up as far as early pricing goes. Once you get into the mid year, pricing is probably not that much different other than the fact that a lot of the rice coming out of Arkansas will go down and go out of NOLA. We, of course, can ship rice in Texas out of the port of Houston. There's a little bit of an advantage from a freight standpoint for guys down here. In general, early in the season, I would say, yes. We have an advantage as we get into the season longer term, things start to a bunch up a little bit.

Rodney: Is there anything, I guess, that you'd pull out that strikes you as maybe materially different in those risks discussions with the Texas farmer versus the Arkansas one on rice, in terms of how you approach the decision-making? You touched on the seasonality and being able to take advantage of being a little off season versus the norms in Texas. Is there anything else in terms of how you look at it or what changes, how you have those discussions?

Dennis DeLaughter: Well, we definitely are talking futures all the time. In our correspondence with our clients, we are talking futures and what the risk is in the futures market. We also talk the cash market, what we're seeing in the cash, what's the risk in the cash market as well. There are two different markets as such, but the farmer themselves, the producers down here, are very interested in the futures market and they do trade the futures. We know it's connected. It may be a wide basis and you can't really factor in basis on that, in that regard. As far as being able to do a basis contract or hedge derives or anything like that, that's not available in rice down here. At the same point in time, most producers here are following the board. They're looking at the board as determining what could be the trend in the cash market based off what's happening in the future.

Rodney: Any real concerns like for that guy that's again, back to the liquidity, we talked about how, "Hey, it's easy enough to work a limit order on the sell side and make sure that you meet your needs." When you go to turn that into cash, we've seen that bid ask be pretty ugly for exiting these shorts. Any suggestions on how guys can manage that better?

Dennis DeLaughter: Well, I think that the market, when people say it has extremely low volume and it does, there's no question about that, but if you start to push the market away from where it's been, trading volume will increase. For instance, if you're talking about on the sell side, if you start to offer the market lower, you're going to start to see the volume pickup at first. Depending on what kind of volume you have to move, that is going to become a major factor. What I have found is that, for instance, the market right now is trading up six and a half cents 12, 13. It hasn't traded in 18 minutes. I'm looking at that saying, "If somebody wants to come in here and offer the market down, they're going to pick up some volume." So it's one of those things where you have to be very patient, you have to work it out and work on it, and what you don't want to do is get caught in a situation where the market is in free fall or what we used to say on the floor, it hits a pocket of air. Because if it hits a pocket of air, then it's going to find it very hard to get that volume done. What will happen is you'll see a lot of these flash crashes, whether they're to the upside or the downside, but if somebody throws a 25 or a 50 lot market order at the market at night, we're going to go down. That's it, we're going down.

Gabe: Please tell me you've never done that.

Dennis DeLaughter: I have never done that.

Gabe: Okay.

Dennis DeLaughter: No, no, no, no.

Rodney: But half speculators, I feel like... I'm looking at rice, seems to be really high price right now, relative, right? And it's pretty easy to open up an electronic trading account. Do you see often where new players come to the market and just wreak havoc in here?

Dennis DeLaughter: Not new players as such, but sometimes, the players right now are the longs in the market like they are in the soybeans, they're up at a pretty high level. And so what we saw coming in, I think it was on Friday morning, there was an order that came in and bang, we just absolutely triggered a big sell off. And you look at that and wonder, "Well, does that guy know what he's doing?" Well, the market's accepted the value that's occurred since then, we've not been able to rally from there. So the market's telling us that, just like you said, it's probably a little bit overpriced, especially after the report that we got on Friday, but the crash occurred before the report came out. And so somebody threw an order in that they shouldn't have thrown in and the market just absolutely fell apart.

Dennis DeLaughter: That happened by the way, Thursday night, 7:00. From 7:00 to like 15 seconds into the trade. I think it was a 50 lot that somebody threw at the market and we just went zoop just like that. So those things are going to happen. That's because you're trading that kind of a market. So now what you do is you, again, you have to be patient and you have to feel the market out and let it tell you what it's wanting to do. And the technicals will tell me a whole lot more than what the fundamentals will. I have been a bear in the market and this has been one of those situations where it's been a kill the messenger type thing. But I felt like that the market was really going to struggle up here at this price range, but there's some bullish news and everybody's excited about the bullish news. We know Brazil's having to buy rice, we know Iraq has gotten approval to buy rice, probably will buy from the United States. At what point we don't know, but there's going to be some buying here. So there's going to be some bullish news that keeps the market, the sellers honest here, at least in the short term.

Gabe: So Dennis, if I'm a farmer that works with you and I was really, prior to Friday, counting on maybe getting up to 1250, which I feel like is a narrative we can imagine, and suddenly, this action happens overnight and I frantically reach out to you. How do you help me kind of think... You encourage patients, right? And these big moves are going to happen, it's going to be painful while it's going on, how do you help people kind of not panic and not pull the trigger in the middle of that air pocket?

Dennis DeLaughter: Well, what I try to do with them is make sure that they're looking at the big picture. In most cases, let's take our Arkansas clients for a second. They're pre-harvest, they're harvesting now. Down here in Texas we're post-harvest, we're past the harvest and so we've got a pretty good idea what the yield looks like, what the grades look like, and what we're up against on the cash marketing side. And so again, we try to take them out of the weeds and up to the 40,000 foot level and say, "Okay, this is where we are." It's easier sometimes in Texas than it is in Arkansas, because in Arkansas, they're priced directly connected to the board. The fact of the matter is, cash price of Texas hasn't moved much. It's sitting exactly where it was before.

Dennis DeLaughter: So it just depends on who the client is. But again, it's talking them through and letting them see the whole view, the 40,000 foot level. I like to be on the... In pre-harvest, I like to be pretty well sold as much as they need to sell and nibbling from the long side with either option strategies or our futures if it's a basis lock-in price like in Texas. And then post-season, it's more obviously going to be board oriented. So there's a long time to go, and try to tell people just not to panic and those kinds of things. And usually they're very good with it. Most people that trade rice or know rice, they understand that this is the condition of this market.

Rodney: Dennis, I'm always excited to talk to a guy that's a real technical trader, I just haven't spent a lot of time on that side of the business. And I'm curious when things like COVID-19 and derecho roll through, those are the hot topics that guys are asking us to talk about. And I just envision a technical trader just trying to completely ignore those events. Just curious what that's like or how you think about that.

Dennis DeLaughter: Well, we put an asterisk on it because obviously the technicals are telling you that in the past when this has happened, this has happened, but it's based off the fact that the market has conditions in it that are known. What I like to try to tell people is if you think about, let's talk corn for a minute, if you think about ADM selling corn to a foreign country, what they're going to do is they're going to make that contract, let's say with China, and then they're going to go to the board and cover themselves. And then they're going to tell me. I'm the last person to know it, but the market is going to sense it, they're going to see it. And that's going to show up in the lines. Well, with COVID-19, there was no way to see this coming. I think what we were slow on the uptake with COVID-19 was the impact on the ethanol. That's what really nailed us as far as that we were slow on that uptake and the market really didn't try to factor that in, or didn't factor it in fast enough. And when it did, we began to see the markets just absolutely work lower, which put the technicals in oversold conditions and saying, "Hey, we may bounce off of this. This isn't probably the best level to be selling based off history." But what we do is we put an asterisk on it, say, "Whoa, things have changed." When the derecho winds came through, we've got an asterisk on that. And that asterisk's on the chart and it says a major change occurred here that the market did not know about. There was no way anybody could trade for that. USDA reports. One of the big questions I get asked every all the time is, do you believe the USDA? Well, the answer to the question is yes, absolutely, because the market believes it. Do I think that's the final number? No, probably not. But at this moment, the market's going to trade that and it's something that the market didn't know. So we can have these reactions based off of that. And rice is just a real classic example of that. When there's something changes, you have to put an asterisk on it and say, this is something that we didn't know was coming and the technicals are going to have to catch up. And they will eventually, and then we can go back to trading them along with the fundamentals. It's not that I don't know the fundamentals, I tell people I'm a fountain of useless information. I know them, but I am going to trust that the market knows something that the fundamentals is not out there yet for the public to digest.

Gabe: And when I look at technical analysis and really anything, anytime we're making decisions based on history, I just think it's important to keep in mind, history is a data point. It's not a constraint. I think that's where all of us get into trouble is when we get to beholden to what has happened, and hold that and keep trying to apply it into things that don't actually have a corollary.

Dennis DeLaughter: And with that said, and I totally agree with that, the idea here is not that you're going to have a ... There is no such thing as the holy grail when it comes to technical trading. There's no such thing. It's not there. What is there is a historical record, just like a chart. When people look at a chart, they don't say, "Oh, that chart's ..." They look at the charts because there's history there. And what we look at from a technical standpoint is it puts the odds in your favor.

Dennis DeLaughter: It just says that, "Hey, there's a 65% chance that if you go back and you go over the last 15 years, when this has happened, 65% of the time, the market has done this." That's what we're looking for, that kind of a thing to give us kind of the house edge. Does it always work?  Absolutely not. If it always worked, I wouldn't be on this call. It'd be on my yacht somewhere in the Bahamas. So no, it doesn't always work, and technical analysis is not something that is always going to be correct. It just tries to give you the odds and put them in your favor.

Gabe: I'm just glad we learned you're a yacht guy. I'm an island guy. If knew how to do take the market, I would just have my island. But I get the yacht. I get the appeal.

Dennis DeLaughter: What I try to tell people is that there's risk in the market, and here's the best way to lay it off. Sometimes that's with an option strategy. We can do that in the rice market. The options do trade, and we can do it that way, or we can do it with the futures. But I'm not a risk taker. That's just never been my nature, fortunately for me. And that's maybe why I've been trading since 1981. I don't know. But I've seen guys on the floor go broke. I've seen people out in the country that have set up this little building because they think they're going to be able to trade and make a whole lot of money, and they go broke with it. It's just not me. I'm more of a risk analyst. So what I'm going to be able to do, and we have been very successful doing that as our clients would tell you, is we are able to determine where the risk is and tell people, "You know what? There's risk in the market here. You may want to lay it off."

Dennis DeLaughter: And if they call and say, "How's the best way to do that?" then we start talking time horizon. How much time do they have? Which of course in the Indigo program is going to be set, and then we're looking at, based off that time horizon, what is the best vehicle to lay off the risk? So once we see elevated risk, and we have a system that's very complex in saying where there's elevated risk, once we see that, then we're looking for a way in which to lay off the risk.

Dennis DeLaughter: What I do not want people to think is that I'm trying to pick a top. I don't do that. That's not the nature. The nature is, is there risk? So if there's risk, we take the risk off. When that risk alleviates itself or is diminished, we like to say, then we can reverse that position and take the risk back on because the risk is reduced. So it's more of a risk analysis standpoint. And so that's kind of how I approach it.

Rodney: Man, so I've dealt with a lot of farmers in my career here, Dennis, and I have yet to meet one of them that would believe that a guy who sat on the Board of Trade, had his own seat, was risk averse. I'd be interested in just a couple of minutes explaining how you can be risk averse and have a seat on the Board of Trade.

Dennis DeLaughter: Well, first of all, I would say that one of the things that I love to do, when I figured it out, is delta-neutral trading. I loved it. So for listeners, I guess I would say that means that you are in a position where which way the market moves doesn't matter. You don't care if it's going up or going down, you're going to make money if you're positioned correctly on the volatility of the market. So I love delta-neutral trading. Second thing I really look at a whole lot is what are the straddles doing? When we look at the difference between ... in options, you're looking, for instance, the $12 ... Let me give you a live situation here, just because I can do that so quickly. We've got the November contract trading around 1220, let's put it 1220. We can look at the straddle there and see where the straddle is trading when it comes to the rice market. And that straddle right now is trading at around 70 cents off the 1220.

Dennis DeLaughter: That means the market's set up for a 70 cent move either direction. So I love to trade that part of it. I think that people get it wrong when they think that traders are always in positions. They're not, either long or short. Delta neutral is a great way to trade it. I might trade it for four or five cents. I will trade multiple contracts. I may be in corn, beans or whatever on the floor, because I'm trying to pick that up. So again, the idea here is to make money. It's not to get rich. The guys who come in there thinking that they're going to put on a position and make four or five million dollars, and that's real simple, that's not reality. That's just not reality. I think that the guys who lived on the floor, those guys made a lot of money as locals because people just traded that way. That I understand. That wasn't me. I'm risk adverse. I am going to make money, which way the market moves as long as I'm right on volatility. Does that make sense?

Gabe: It does. I would say, I think one thing you talked about the locals making a lot of money, a lot of those guys also weren't directional traders, right? They were just making money off of very ... a high number, what we would call high frequency trading now, whatever qualified for that back in the pre-tech days, pre-screen days.

Dennis DeLaughter: Exactly, yeah. Yeah, that's why, if you ever saw the floor, you'd see the locals standing there, bid and offered at the same time, their bid at one, offered at another. They're sitting there, they're trying to get that broker's edge. Think of it from this standpoint, when somebody traded the market, if you put an order in to sell at the market, it's going to go to that back row of the pit. That guy's going to turn around and look in the pit and find a guy who's got his hands turned in and he's going to hit him and sell it. He's not going to be trying to pick out a price. It's a market order, so he's going to hit it. And so then he's turning around and there's another guy who's coming at the same point in time, and he's going the other direction. And so he's going to be on the buy side, so he's looking for a guy with his hands out. So all of a sudden that guy makes a quarter of a cent. You do that on 200 contracts, and things are looking pretty good. So yeah, you're exactly right.