Market Commentary for 2/2/18
The groundhog saw it's shadow this week and it reminded me of the movie Groundhog Day. Similar to the plot of the movie, the corn market is repeating itself day after day, week after week and now month after month. No one knows when or what will cause the cycle to end.
Beans, on the other hand, are primarily driven in the short-term by Argentina weather for the next few weeks.
How I'm Generating Higher Prices In A Low Price Market
For the last 6 months the corn market has gone nowhere. Farmers don't want to sell at low prices, and supply doesn't warrant end users to pay up for corn. Consequently, prices are stuck at undesirable levels for most farmers. Still, it's essential for my farm operation to get the highest possible prices. This has meant considering alternative solutions in my market strategy. And in the past year, I've had some success increasing profits by selling options, specifically calls and straddles.
What Does It Mean To Sell A Call?
This means I'm willing to sell to someone else the right to buy my grain at a specified value. On the day the option expires, if the market is above that value, I have to sell my grain. If it's lower, I don't sell the grain. In both cases, I keep the premium of the sold call.
What Does It Mean To Sell A Straddle?
This means selling a call option and a put option at the same value (i.e. strike price). On the option's expiration date the closer the current market price is to the strike price of the option, the more premium I will receive. The further away from the strike price value, the less value I will receive. While I think straddles provide a great hedging opportunity, there is some risk. If the strike price falls far enough, I may have to buy grain at a price above current market values.
Often analysts dramatize the risk associated with selling options, most likely because they look at it from a speculators' point of view (not a farmers'). I think this is unfortunate because farmers should be aware of all their options and the consequences of ANY price direction. Admittedly selling options has some risk, but so does buying options (which is frequently suggested by media analysts). In my opinion buying options, and specifically corn options, can actually be far more risky for a farmer than selling those options.
I think it’s important to know all of your choices first, and then make the best marketing strategy decisions for your farm operation. Following provides another recent example of how selling a call and a straddle is helping my farm operation get higher prices when prices are generally unprofitable.
The following trades expired on 1/26/18. Following shows my rational for originally placing the trades and the final outcomes.
On 11/16/17 when March corn was $3.49, I made the following trade on 10% of my ’17 production
- Sold – February $3.55 straddle, where I sell both the $3.55 put and $3.55 call and collect just over a 17 cent premium
- Trade Expiration - 1/26/18
- Potential Benefit - If March futures close at $3.55 on 1/26/18, I keep all of the 17 cent premium
- Potential Concern - Reduced or no premium if the market moves significantly in either direction
- Every penny lower than $3.55 I get less premium until $3.38
- $3.38 or lower and I will be losing money on this trade penny for penny
- Every penny higher than $3.55 I get less premium until $3.72
- $3.72 or higher - I have to make a corn sale at $3.55 against March futures, but I still get to keep the 17 cents so it’s like selling $3.72
On 12/1/17 when March corn was near $3.59 I sold the following call:
- Sold a Feb $3.55 call for 10 cents – expires Jan 26th on 10% of my ’17 production
- If corn is trading below the strike price when this option expire - I keep the 10 cent premium and add it to another trade later.
- If corn is trading above the strike price when this option expire - I have to sell corn for the strike price PLUS I keep the premium, which means, I will have a price of $3.65 on the trade ($3.55 10 cents option premium).
On 1/25/18, one day before both trades expired, corn was trading at $3.56, so I bought back both sides (both the puts and the calls) of the straddle for 3 cents. This means I made 14 cents in profit on this trade (17 cent sale - 3 cent buy back).
On 1/26/18 corn was still trading at 3.56, so I let the sold call get exercised and it turned into a short futures position of $3.55.
Why Let The Call Sale Get Exercised And Not The Call In The Straddle?
Sold Call - I could have bought back the call, but I'm behind in my '17 sales and I expect the sideways market to continue. This trade ultimately was better than selling corn originally (on 12/1/17) at $3.59 futures because I received a sale for $3.55 plus the 10 cent sold call premium (so $3.65 combined). Now I'll take the futures sale from this trade and roll it forward to July to pick up the market carry, which is around another 16 cents of profit. (Note, I haven't actually rolled this trade forward yet, so there is some minor spread risk still.)
Sold Straddle - I didn't intend to sell or buy back any grain on the straddle trade when I placed it. While I was willing to accept either outcome if it happened, they were really the worst case scenarios. My goal for the straddle was to make as much premium as possible and then add it to a future trade, increasing my sale price levels. I’m very pleased with the outcome of this trade.
I can actually add the straddle premium to my sold call and new futures sale. Following provides the theoretical final value of this trade which represents 10% of my ’17 production:
$3.55 Futures Sale
.10 Call Premium
.14 Straddle Premium
$3.79 Against March Futures
.16 Market Carry Potential
$3.95 Potential Final futures Price
This trade takes me from around 15% sold on my ’17 crop to nearly 25%. My average sale price is still unknown right now because of the many options positions open for the ’17 crop.
By selling options I'm able to manufacture corn prices at levels that are much closer to profitable levels, which is mandatory for my farm operation's future success. While some farmers prefer to wait and hope for prices to go back up in the futures, I'm using the relative "consistency" of the current sideways market to make added profit in the meantime. I’m hoping prices go up too, but what if they don’t? I plan to grind premium out of the market until then to make my farm operation as profitable as possible.
Superior Feed Ingredients, LLC
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