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Market Commentary for 6/26/20
The market fell another 15 cents this previous week due to several factors:
- Weather has been generally good. There have been timely rains and few dry areas throughout most of the Midwest. Also, forecasts don’t indicate widespread, long-term dry patterns.
- Covid-19 cases are increasing in many areas throughout the US, which suggests slow business re-openings and less ethanol consumption.
- Mixed reports out of Washington indicate possible trade tensions between the US and China, which is spreading uncertainty among market traders.
- Old and new crop carryout estimates continue to look high
This Tuesday’s USDA report is arguably the biggest of the year. Last year everyone was shocked by the estimated US planted corn acres. This year the trade is assuming farmers have planted about 2 million acres less than the 97 million acres reported in March. For December corn to trade above $3.50, we will likely need less than 94 million planted acres. Anything higher than 95 million acres, and prices likely drift lower.
Due to Covid-19, 2 recent straddle trades didn’t go as planned. While it’s always disappointing when this happens, it’s important to review what happened, what can be learned from the situation, and how to move forward in a positive way.
My History with Selling Straddles
Since 2016, selling straddles has represented about 30% of my grain marketing strategy. I use them to try and capture profit from a sideways market. The trade involves selling both a put and a call at the same strike price.
Selling straddles helps me maximize profit potential when the market stays sideways, which has happened a lot in the last 3 years. Plus, selling straddles can also force sales at higher values, which makes for a strong strategy. As a producer I’m happy with rallies because, I always have more grain to sell at higher prices.
The Downside of Selling Straddles
Straddles don’t have a built-in floor price, which opens me up to unlimited downside risk. I can minimize that risk by purchasing out of the money puts, but those added costs cut into my profits. With a consistent sideways market, purchasing puts previously seemed like an unnecessary expense for the 6 months after harvest is complete.
In February I sold my 50th straddle in the last 3 years. Of those 50 straddles:
- Nearly 70% had provided me some type of profit on the trade.
- About 20% turned into a forced sales position to the upside. Half of those were in 2019 alone.
- Only 10% lost money – those losses amounted to only 2, 10, 10, 15 and 25 cents each or 62 cents total over the 3 years.
How Often Do You Purchase Protections in Case the Market Drops?
I've bought put protections to protect my downside about 20% of the time, and it's usually when the straddles are expiring in the last half of the year when the corn market is in a seasonal downward trend. Typically, it costs between 2-8 cents, with the average costs around 4 cents, to have a floor protection on my straddles. This means on the 40 trades where I didn’t buy put floor protection, I’ve saved at least 160 cents over the last 3 years.
2 Recent Straddle Trades Results:
On February 19th May corn was trading $3.85. I sold an April $3.90 straddle collecting 14 cents and a $3.90 May straddle collecting 20 cents.
From 11/1/20 until 2/1920, May corn had traded between $3.76-$4.00. At the time it seemed carryout could get tighter because there was less corn in the US than the market believed only a few months prior. Therefore, it seemed reasonable that corn would trade sideways or a bit higher as we moved further into Spring. At that time, it seemed unlikely the market would trade much lower given the recent range.
With the straddle trades now in place I could make a profit on each trade if the market was between $3.76-$4.04 when the April straddle expired at the end of March, and between $3.70-$4.10 at the end of April when the May straddle expired. The previous 3 months indicated that we would likely stay in that range. If the market was above these ranges, I had to sell at the top of each range, which I was fine with doing. While the downside potential was possible, we would still have the weather markets of the summer ahead of us. This seemed to indicate a long-term sideways pattern was probably present, and that these trades seemed like a good decision.
Covid-19 hit, and it was worse and lasted longer than many could have imagined. Shelter in place programs killed gasoline and ethanol demand. I was forced to buy back the put portion of the April trade for a 32-cent net trade loss and the May trade for a 50-cent net loss. Luckily these trades only represented 10% each of my 2019 production.
Should I Have Bought Purchase Protections?
Hindsight is 20/20, so yes, I wish I would have for these 2 trades. However, it’s important to keep things in perspective. If I total up all of my losses, now on 7 of 53 total straddles in the last 3 years, I’ve lost 144 cents. Since it would have cost me about 160 cents to buy floor protections on the 43 straddles, I never bought put protection on, I’m actually ahead over the long run.
When the April straddle was about to expire, and July corn was still trading $3.55, I replaced it with a July $3.50 straddle and purchased a $3.20 put while collecting 32 cents of profit. This gave me full downside protection on the trade and force me into a $3.82 sale if the market was higher at expiration. Unfortunately, corn went lower and this trade expired on Friday with July at $3.18. This means that I walked away with 2 cents profit on the trade, which covered all of the commissions. Actually, had I not bought the 6 cent put protection on this trade, I would have made 6 cents more profit on the trade. However, with the uncertainty of the markets during these times I felt it prudent to cover all downside risk.
I replaced the May straddle with a September $3.20 straddle on April 22nd when September corn was trading at $3.30. After purchasing a $2.90 put protection floor, I collected 36 cents profit. The straddle forces a sale at $3.56, but with what I know today that may be difficult. Regardless, I have a guaranteed 6 cent profit on this trade no matter how low corn goes at the end of August.
While I’m disappointed with any loss, these two were mostly due to an unprecedented pandemic that most didn’t see coming. Of 53 total straddles I have now traded in the last 3 years, 67% of the time I’ve turned a profit. 20% of the time I’ve had a forced sale that I’ve been happy with making. That means selling straddles has had an 87% success record as part of my grain marketing plan.
Just because a couple trades didn’t go my way, I’m not going to abandon a trade strategy that’s helped me be profitable during sideways markets in the past so consistently. After all, with prices so low right now, I need to use every tool in my grain marketing tool box to maximize profit potential. Sideways market will likely happen again.
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