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Hoping for a rally but preparing if there’s not

By Jon Scheve, Superior Feed Ingredients, Inc.

I travelled from Minneapolis along I-35 to Des Moines and west on I-80 to Lincoln last week. I was amazed at how few acres had been harvested for a crop that was supposed to be so far along. I saw nothing harvested until I was near Ames, Iowa and even then only about a dozen combines running between Des Moines and Lincoln. It seemed that what had been harvested was evenly split between corn and beans.

The trade issues continue to hurt beans and expected yields are very high, which will lead to a large carryout. Last week, futures rallied on the hope that exports will be higher than the USDA is forecasting. Some speculators are buying in their profitable short positions to reduce risk. Consequently basis at processing plants dropped, and there is still very weak basis around the country, which to me suggests that the upside for bean futures is still not there.

Corn appears to be the better value post-harvest based upon expected 2018 carryout levels. Still, big crops often end up being bigger than initially estimated, which would mean more supply than estimates suggest. If demand doesn’t keep up, upside potential will be limited.

A recent private analysis estimated corn planted acres for 2019 will increase, suggesting corn is bearish in the long run. I suspect a weather issue would be necessary to change that view. Bean acres were forecasted to be much lower, but without a trade resolution, it’s hard to estimate an outcome long-term.

Like all farmers I need corn to rally. With prices at unprofitable levels and the expected widespread high yields this harvest, I’m concerned this sideways market will continue a little while longer. Rather than sitting around waiting and hoping for a rally, I’m going to manufacture trades that can help me try to attain profitable levels, even if prices don’t rally. But, I also want to allow for some upside potential if a rally does come.

Following are two trades that illustrate alternative grain marketing solutions that provide the opportunity for profitable prices, even if a rally doesn’t come.

 

Trade 1 – Sold Straddle

On 8/30/18 when Dec corn was around $3.58, I sold a November $3.70 straddle (selling both a put and call) and collected just over 23 cents total on 10% of my 2018 production.

What does this mean?

  • If Dec corn is $3.70 on 10/26/18, I keep all of the 23 cents
  • For every penny corn is below $3.70 I get less premium penny for penny until $3.47.
  • For every penny higher than $3.70 I get less premium penny for penny until $3.93
  • At $3.93 or higher I have to make a corn sale at $3.70 against Dec futures, but I still get to keep the 23 cents, so it’s like selling $3.93
  • At $3.47 or lower I have buy corn sales back or simply take a loss on this trade.

 

My trade thoughts and rationale on 8/30/18

This trade is most profitable in a sideways market. After hot and dry weather throughout August, a yield increase in the September report is uncertain. Still, typically corn bottoms out on the last trading day of August and starts increasing through October. While I’m comfortable with any outcome, I think the market continuing to trade sideways is the most likely with what I know today, I’d be happy collecting the premium to add to a later sale.

 

Trade 2 – Bought October puts and sold a March call 

Two weeks after I placed the trade above, many farmers had reported to me that their expected yields looked even better than what they thought the previous month. So, suspecting a potential yield increase in the September USDA report, I put some protections in place similar to trades I did before the August report.

On 9/10/18 two days before the report when Dec corn futures were $3.67, I did the following 2 trades at the same time:

  • I bought October $3.60 puts to cover 40% of my 2018 production for a total of 10 cents (2.5 cents each).
  • I sold a March $3.90 call for 14 cents on 10% of my 2018 production.
  • Basically, I bought 4 Dec puts for every 1 March call I sold.

After commissions, I was able to net just over a 1-cent premium on 10% of production between the two trades.

What does this mean?

These trades, combined with my other positions, provide good protection for any outcome of the September USDA report.

  • With a bullish report I only have to sell 10% of my production for slightly below $4 (depending where prices are in late February).
  • With a bearish report I’m protected at 7 cents below what the market was trading for on the day I made the trade until Sept. 21 (10 days after the report).
  • With a sideways report all of my other trades I have working would likely add more money to my “pot of premium” that I can later add to my sale prices.
  • There is a chance that both trades could hit. Prices could tumble after the report and my puts make money or get exercised. Then after harvest the market could rally high enough that my March calls also get exercised.

 

What happened?

The USDA increased yields more than anticipated, pushing prices down immediately after the report and through Wednesday of this past week. The market then rallied 14 cents off those lows through Friday’s close.

On 9/21/18 when corn was trading $3.565, I sold back 3 of the 4 puts collecting 3.5 cents each, or 10 cents total on 10% of my production after commissions. I left the last put position in place to get executed and turn into a $3.60 sale against December futures.

I may still have to make a $3.90 sale against March futures on another 10% of my production. Given prices today, I would be happy with that outcome.

 

Why make a sale at $3.60?

For one, the 10-cent premium from the other puts makes this sale really at $3.70.

Two, being sold going into harvest allows me to take advantage of upcoming market carry potential.

Three, I’m not sure which direction the market will trade over the next month. Leaving this trade on allows me to stay protected against the $3.70 November corn straddle in trade 1 expiring in a month.

  • If corn is below $3.60 on Oct. 26, I can let the November straddle reverse the sale with the $3.60 put turned futures and net 13 cents between the two trades on 10% of my production. In other words, I would keep the 10 cents from the options in trade #2 and the 13 cents from trade 1 and have no additional sales in place. I can then add that 23 cents to a later trade.
  • If Dec futures are above $3.60, but below $3.93, then I will take the profit from the straddle trade 1 and the puts trade 2 and add them to the $3.60 sale. The closer to $3.70 at the end of October, the better. If prices are a lot higher than $3.70, the worse this trade gets, but that is better for all my remaining unpriced 2018 grain.

 

My 2018 current corn position

After the sale above, 55% of my ’18 crop is sold with a futures values around $4.03 against the Dec. I have options positions working on another 40% of my production that would allow me to have almost all of my crop sold at values over $4. The actual values vary depending on where the market goes over the next several months. I’ll have a better idea of my exact final position once more of my options positions expire through December.

Like all farmers I want prices to rally, but I’m also preparing if they don’t.

 

Jon grew up raising corn and soybeans on a farm near Beatrice, NE. Upon graduation from The University of Nebraska in Lincoln, he became a grain merchandiser and has been trading corn, soybeans and other grains for the last 18 years, building relationships with end-users in the process. After successfully marketing his father’s grain and getting his MBA, 10 years ago he started helping farmer clients market their grain based upon his principals of farmer education, reducing risk, understanding storage potential and using basis strategy to maximize individual farm operation profits. A big believer in farmer education of futures trading, Jon writes a weekly commentary to farmers interested in learning more and growing their farm operations.

Trading of futures, options, swaps and other derivatives is risky and is not suitable for all persons. All of these investment products are leveraged, and you can lose more than your initial deposit. Each investment product is offered only to and from jurisdictions where solicitation and sale are lawful, and in accordance with applicable laws and regulations in such jurisdiction. The information provided here should not be relied upon as a substitute for independent research before making your investment decisions. Superior Feed Ingredients, LLC is merely providing this information for your general information and the information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision. The contents of this communication and any attachments are for informational purposes only and under no circumstances should they be construed as an offer to buy or sell, or a solicitation to buy or sell any future, option, swap or other derivative. The sources for the information and any opinions in this communication are believed to be reliable, but Superior Feed Ingredients, LLC does not warrant or guarantee the accuracy of such information or opinions. Superior Feed Ingredients, LLC and its principals and employees may take positions different from any positions described in this communication. Past results are not necessarily indicative of future results. He can be contacted at jon@superiorfeed.com.

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