Lessons Learned On An Unprofitable Trade
Jan 08, 2018
Market Commentary for 1/5/18
While it's a new year, there is nothing new for corn prices. A sideways market for the next 3 months seem likely.
There are indications that farmers are willing to start selling as futures approach $3.60-$3.70, but will hold under $3.50. On the flip side, end users indicate they don't have much coverage and will buy during any market dips.
Bean prices are now largely driven by rain in South America. As the South American mid-summer approaches, they have had perfect growing conditions so far; however, mid-February is when moisture levels are most critical. Add to that, US exports are not pacing as planned to meet USDA estimates, and higher prices than the current upper $9’s will be difficult.
Options – Straddle – Beans
As a part of my marketing strategy, I always understand all possible outcomes of each trade I do, and I make sure I'm willing to accept all potential scenarios. Unfortunately, the following bean trade example illustrates that despite careful planning and doing trades that align with historical trends to maximize profitability, the worst case scenario sometimes happen.
It's not a big surprise that this happened in beans. Bean prices compared to corn are usually more volatile and unpredictable. Some of this is due to 60% of the world’s bean supply being produced in South America. Still I think that it's important to be fully transparent, not only for credibility reasons, but also because there is a lot to learn in worst case scenarios for the next time I place a trade.
When developing my market plan and strategy I always write down for each trade the detail and rationale for why I placed it and all possible outcomes. Then when reviewing the trade later I can remember my mindset at the time. Following shows the trade detail and rationale for why I placed this trade two months ago, as well as the results and current situation.
On 10/27/17 I was 100% sold for my 2017 crop when Jan futures were trading at $9.85. I sold a $10.20 straddle for 45 cents (sold a $10.20 put and a $10.20 call for a total of 45 cents premium) against 20% of my '17 production. Note, any additional sale over 100% of 2017 production will be moved to 2018 production.
- Trade Expiration - 12/22/17
- Expected Market Direction for the next 2 month - When analyzing historical trends, South America usually has a weather concern between 10/27 and 12/22, which causes bean prices, already low during the U.S. harvest, to bounce off the bottom and rally.
- Potential Benefit - If Jan futures close at $10.20 on 12/22/17, I keep the 45 cent premium to add to my sales average.
- Potential Concern - Reduced or no premium if the market moves significantly in either direction
- Every penny lower than $10.20 I get less premium until $9.75
- $9.75 or lower – the $9.80 sale I had in place will be wiped away, but any profits gained on that trade and from market carry will still remain. Which probably will be at most 15 cents in total profit.
- Every penny higher than $10.20 I get less premium until $10.65
- $10.65 or higher - I have to make an additional bean sale at $10.65 against Jan futures.
In summary, I would be most profitable on this trade if beans rallied some by 12/22/17. Historically, the market usually rallies during this time period because South America almost always has a weather concern somewhere. I wanted to take advantage of this high likelihood and maximize my profit potential, hence I did this trade. While I was willing to accept the outcome if prices went below $9.75, it seemed unlikely because it basically required perfect weather throughout ALL of South America, which would be a rare event.
There WAS perfect weather during this time period throughout South America and Jan futures were trading below $9.75 on 12/22/17. Therefore, the sold call portion of the straddle expired worthless and I let the sold $10.20 put get exercised, which means I'm now long a $10.20 futures position against Jan futures. However, I still have the 45 cent premium I collected from the trade, which means it’s like I had to buy beans for $9.75 ($10.20 less the 45 cent straddle premium). Obviously, in hindsight I'm disappointed with this trade.
What Did You Do Next?
On 12/26/17 I rolled this long position to March futures. Since March futures were 11.5 cents higher due to market carry than Jan futures at the time, it meant reowning some beans for $9.865 (9.75 11.5 cent carry) after commissions against the March futures. When I’m long futures and I have to roll forward, it means I have to sell out the Jan futures and buy back the higher March futures. So, now I'll need something to help the market rally, so I can sell these beans back and at least breakeven on this trade.
On the surface one might think this was just a bad trade, but that wasn't the problem. There was a lot of rationale based upon historical trends to place this trade and there was even some risk management built in to minimize losses (i.e. I would not have lost money even if the market had remained sideways). The problem - I was overly bullish beans when an unlikely and uncommon event pushed the market lower.
With some hindsight, I should have still sold the straddle, but I picked a lower strike price....like one where futures were on the day I placed the trade instead of going for a higher value. Had I picked $9.80 instead of $10.20, I would have made 10 cents instead of being out 30 cents when this trade expired and now hoping for a market rally to get me back to breakeven.
So with the removal of a previous sale due to the straddle, here is my current bean position:
Why I Dislike Grain Reownership
This example illustrates why I'm usually not a fan of grain reownership and why I limit it within my grain marketing plan. All too often it adds more risk and potentially lowers profits. Now granted, reownership was the worst case scenario of this trade, I knew it was a possibility when I placed it and historically a market drop during this time frame was unlikely. Still, I'm disappointed. In this case, not on the trade but the selected strike price. I should have been a little less aggressive/bullish.
It's impossible for farmers to market their grain perfectly all the time. The lesson from above is not to avoid complicated marketing strategies or alternative opportunities when one doesn't work as hoped. Instead, farmers need to review each trade, understand what they did wrong and learn from their mistakes to try and help themselves stay as profitable as possible year after year.
Superior Feed Ingredients, LLC
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