Power Hour: Nervous Over Reports? Weigh Short-Dated Options

March 28, 2014 07:00 AM
Power Hour: Nervous Over Reports? Weigh Short-Dated Options

It's true that major market moves are possible next week: Four of the last seven years have seen limit corn moves following release of USDA’s March prospective plantings and grain stocks reports, and there is extreme variability in trader expectations about what the reports have in store.

But savvy marketers can guard against surprises using short-dated options.

These instruments protect against key events, particularly downside risk, at a fraction of the price of traditional options, says David Hightower, president, The Hightower Report. He acknowledged this week during a CME Group pre-report strategy session that while he is bullish, extreme price volatility this year could move the market bearish.

"Nobody knows where the bottom of the market is," he admits. "We see December corn in an uptrend but the potential for a 30- to 40-cent downside move, depending on the report." 

Uncertainty over Eastern Europe as well as China--particularly if PEDV hits China’s pork sector--is also a factor.

(Click here to watch more news and video on Top Producer's Power Hour.)

To guard against potential bearishness, Hightower suggests that producers consider new-crop short-dated options. They offer significantly lower premiums than traditional options because of their limited time value. One strategy he suggests: Buy two $4.80/bu. puts expiring in May (based on the December contract) with premiums on March 26 of 11.38 cents.

"If, following the reports, the corn market breaks 30 cents, producers could liquidate one, or both," Hightower says. "I like the latitude of multiple options."

He sees at least $1.50/bu. downside risk for new-crop soybeans assuming expected conditions, but even greater risk if a late spring forces producers to switch intended corn acres to soybeans with heavy Chinese cancellations.

"The trade expects a bullish grain stocks report," he adds. That means a report surprise could send prices lower. The producer strategy he likes is to buy $11.60 short-dated options for the November contract that expire June 20. Premium cost on March 26 was 27 cents. "This protects producers against significant downside risk."

Hightower shares expectations for March 31

Widely varying expectations about Monday's reports support the notion that 2014 will be a volatile year in the markets.

"There’s a 5 million acre spread of trade corn estimates—90.5 million to 95.5 million acres," Hightower says. While he expects less corn, he anticipates total acreage of corn, soybean and wheat to be up 2 million to 3 million acres.  

"The corn market is more bullish than three months ago," Hightower notes. "We believe long-term corn demand will remain strong, maybe even stronger."

In addition to being bullish on exports, Hightower is bullish about ethanol and feed demand.

"There’s no blend wall on ethanol," he argues. "If we don’t use it here, we’ll export it." The demand wild card, he acknowledges, is China. That country's corn imports are too tough to predict. Still, he looks for China to be a growing market for U.S. corn and notes that China has relaxed its corn self-sufficiency targets to 92%, down from 95% to 96%.

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