Scheve: How I Lost On A Straddle Trade Last Week
Jun 25, 2018
Market Commentary for 6/22/18
Practically everyone in the grain trading world is saying "I didn't see that coming" after a 70 cent corn price drop over the last 30 days and a $2/bu drop in soybeans. I know I'm not the only one disappointed that prices are back to levels last seen in January. At least the market has come off of its lows from Tuesday and is only down 50 cents in corn and $1.50 for beans.
While I wish I would have sold more futures during this last rally, knowing what I know now, I'm glad I sold what I did above $4.25. At the time I sold those bushels I was worried $4.50-$5 may be possible and that those sales would turn out to be a mistake.
It's easy when negative and unpredictable things happen to fall into the "if only" trap, but there's too much uncertainty to spend significant time dwelling on what should have been done. No one knows what's going to happen, and certainly no one can predict the weather, the biggest driver of prices. We only know current conditions....and 30 days ago we knew....
- Corn was planted 1-2 weeks later than usual
- Normal yields with average rainfall would likely mean that for the 2018/19 marketing year:
- A decreased world stock level by 20%
- The lowest corn carryout in the US in 5 years
- The tightest "Stock To Use Ratio" in 40 years
- Weather forecasts indicated:
- Increased dryness throughout the southern plains
- Memorial Day Weekend would be hot - 100 degrees throughout the corn belt
- June would likely continue to be hot
- There were global dryness concerns outside the US
- There were potential trade concerns, but the market had responded well after a couple days with each announcement up to that point.
- Trendline yields around 174 bu/acre would have likely meat $4 Dec corn by Thanksgiving
What Do We Know Today?
Crop conditions are off to a great start, maybe the best ever, with widespread timely rains and warm weather. Even with the delayed planting, the intense heat has help speed up the growth of the corn and pollination will likely happen during the normal time period. It is unlikely that there will be many prevent plant acres, so corn could actually see an increase in planted acres. If fantastic weather continues, the national yield averages could hit 180 or 182, which would mean carryout exceeding 2 billion, up from 1.6 billion only 2 months ago. This could set up the market for a situation similar to last year.
Each bushel/acre increase over the 174 national yield average would likely mean 10 cents off a $4.00 Dec corn price. So, an average 180 national yield would mean Dec corn probably trading $3.40.
What Don't We Know Today?
- Will Good weather continue through pollination and grain fill?
- Will the last half of July and Aug be hot, or will there be cool nights?
- Will too much rain be a factor? That has only happened once in the last 30 years, so it's probably a long shot.
- Trade/Tariff Issues have received a lot of press recently, but they too are impossible to predict. The US produces 30% of the world's grain, so there isn't enough global supply to support the world’s needs without the US supply. In the short term, headlines can make some market shifts, but like weather, no one knows what will happen.
Market Action - July Options Expired - Corn
Trade #1 - Sold Call
When the market was moving toward its low for the year last season on 8/31/17, I sold a $4.00 July call for 19 cents (5% '17 production)
What does this mean?
- If July corn is above $4.00 on 6/22 - I have to sell corn for $4.00 and keep 19 cents ($4.19 total)
- If July corn is below $4.00 on 6/22 - I keep the 19 cents to use on another trade in the future
Trade Thoughts On 8/31/17
I hope corn rallies above $4 before July, but it's unlikely knowing what I know today. Therefore, getting an additional 19 cent premium to add to a later trade will be helpful in maintaining profitability if prices don't increase.
Corn closed below $4.00 and I just collected the 19 cents.
Trade #2 - Straddle
On 2/26/18 when July corn was $3.82:
- Sold a $3.90 straddle (where I sell both the put and call for the same strike price)
- Bought a $3.60 put to minimize downside risk in this trade
- Collected a total of 28 cents premium for the trade
What Does This Mean?
- If corn is below $3.62 on 6/22/18, I don't get to sell any corn and I could lose up to 2 cents max
- If corn is above $4.18 on 6/22/18, I have to sell 10% of my 2017 production for $3.90 plus the 28 cents from the sale of the options, so I would get $4.18 total.
- If corn is between $3.62 - $4.18, I will make some premium on this trade but no sale has to be made. The closer July corn is to $3.90, the more of the 28 cents premium I get to keep.
Trade Thoughts On 2/26/18
Worst Case Scenario – prices fall below $3.62 and I lose 2 cents. I think this is unlikely, but I'm prepared if it happens. Any price above $3.62 and I'll be pleased the results.
Corn closed at $3.57. I lost 2 cents and didn't sell any grain.
Trade #3 - Straddle
On 4/17/18 when July corn was around $3.88, I sold a July $4.10 straddle (sold both the put and the call) and collected 34 cents total on 10% of my production
What Does This Mean?
- If July corn is $4.10 on 6/22/18 - I keep all of the 34 cents
- Every penny corn is below $4.10 - I get less premium until $3.76
- If corn is $3.76 or lower - I will have to remove a sale by buying back futures
- Every penny higher than $4.10 I get less premium until $4.44
- $4.44 or higher - I have to make a corn sale at $4.10 against July futures, but I still get to keep the 34 cents so it’s like selling $4.44
Trade Thoughts On 4/17/18
As with all straddles, this trade is most profitable if corn stays sideways. And while I think corn has upside potential, I don't think it's likely to rally higher than the top of this straddle's range (but I'll obviously be happy if it does). The biggest concern of this trade is the downside. Corn demand will have to stay strong and a weather scare would help.
I think there is a good chance corn will be between $3.76-$4.44 at the end of June, with what I know today. Even this week May corn didn't drop below the lower limits of this trade. And since I sold 20% of my corn the previous week, buying back some of this sale (worst case scenario) is acceptable risk, given the potential reward of the trade.
Unfortunately, the market collapsed the last 4 weeks and we finished below $3.76. Perfect rains and tariff issues were too much for the market to bear. It turns out I was too aggressive with my plan for higher prices.
I didn't want to buy any of my previous sales back, as I stated above because it would have meant buying $4.10 July futures. Since I'm uncertain where the market will go next, I instead bought back the put portion of this trade for 55 cents before it expired and let the call portion of the straddle expire worthless.
After the 34 cents I collected from selling the straddle originally, I have a 21 cent net loss (34 – 55 = -21) on 10% of my ’17 production that will be subtracted from my pot of premium I've been collecting all year long.
The Results Of Using Straddles This Past Year
In the last year I've had a lot of success using straddles to collect extra premium during a long-term unprofitable sideways market. Along the way I have shared the results of those trades in these newsletters, both the winners and the losers. Here is a quick recap of the results:
- Since 6/20/17 I've placed 14 different straddle trades, with 11 of the 14 being profitable.
- 11 Trades each on just 10% of my ’17 production added to my pot of premium 1.89 cents total ( 18, 8, 12, 37, 7, 14, 5, 38 18, 7, & 25)
- 3 Trades each on just 10% of my ’17 production removed from my pot of premium - 37 cents total (-14, -2 & -21)
- My net premium from trading straddles is 1.52/bu on 10% of production or 15.2 cents on every bushel I raised this past year.
While overall the last year, I've had many successes, I'm disappointed the two straddles above were losses (specifically trade #3). In hindsight I had too much faith the market would remain strong through July 4th and should have bought a put for downside protection, which would have limited my loss to 5 cents only. But with delayed plantings in April, and a potential big drop in carryout next year it seemed unlikely there would be perfect crop conditions in June. Back then I feared the market was going to go way up and selling too low, then I was with the market going down.
With an 80% success rate selling straddles on ’17 crop, I probably won't stop using them. But the straddle trades that just expired are an important reminder that the market is unpredictable and even when it seems impossible that the market could go down, it still can. So, it's important to always understand all possible outcomes for each trade and be willing to accept them all.
Superior Feed Ingredients, LLC
9358 Oak Ave
Waconia, MN 55387
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