Market Commentary for 8/25/17
Recent crop tours have not provided enough support that USDA estimates are completely off base. This caused even more pressure on the market this week. Crop size will be debated until harvest is over and without a major surprise, the upside seems limited.
For many elevators and end users 8/31 is the last official day of the 2016 grain marketing year, many will want farmers to have their Deferred Priced (DP) grain in storage to be priced. Last year the market traded lower the entire week prior which was the lowest of the year, that is expect again this year. Some estimates suggest that 10% of the ’16 crop could be priced sometime during this week.
A 167 national yield average, as suggested by a recent crop tour, would likely still mean a 2 billion bushel carryout this year. At 169, as suggested by the USDA, the carryout would be just as high as last year. Some say exports may increase with prices dipping, but it will be needed to compete with cheap Brazilian corn.
The next 6 months could be rough for farmers. However, in the last few years we've seen farmers not sell when prices are really unprofitable, which has helped prices rebound shortly after harvest. If farmers can hold out and not sell right away, it may work again.
Sometimes It's Wise To Bet Against a Rally
All grain farmers are hoping for a price rally that places corn prices at profitable levels. With prices below profitable levels for over a year, it gets frustrating and discouraging waiting for good prices. That's why I look for opportunities in the market where I can make additional profits without a rally. Throughout summer I expected a mostly sideways market; therefore, I made several trades that would add additional premium if the market went nowhere. While I was correct that the market moved sideways the last few months, I was always prepared on each trade I made for any market scenario (i.e. managing my risk). With Sep options expiring Friday, following are my trade results.
Previous Trade from 5/17/17
- Expected Market Direction - Sideways into late summer
- Trade Detail - Sold Sep $3.70 straddle for 38 cents
- Position Size – Trade represents 10% of ’16 OR ’17 production
- Expires - 8/25/17 - after crop conditions are known
- Potential Benefit - If Sep futures close at $3.70 on 8/25, I keep the 38 cent premium
- Potential Concern - reduced or no premium if the market moves significantly
- Every penny lower than $3.70 I get less premium until $3.32
- $3.32 or lower - a previous corn sale is removed, but any profits gained on that trade can be added to a future sale.
- Every penny higher than $3.70 I get less premium until $4.08
- $4.08 or higher - I have to make another corn sale at $4.08 against Sep futures
- If a Sep sale is initiated then I can move this sale to Dec futures and pick up about 10 cents of premium and thus have a $4.18 sale in place. At this point the sale would likely be against my ’17 crop
RESULT - I bought back the put for 31 cents and let the call expire worthless (saving on commissions). I made 7 cents on this trade.
Previous Trade from 7/21/17
- Expiration - 8/25/17 – after first crop yield report is published
- % Production – About 10% of ‘17 corn production
- Potential Benefit - If Sep futures close at $3.80 on 8/25, I keep the 26 cent premium
- Potential Concern - Reduced or no premium if the market moves significantly in either direction
- What Does This Mean:
- Every penny lower than $3.80 I get less premium until $3.54
- $3.54 or lower - an original corn sale would be removed, but I keep the 26 cents to add to another sale.
- Every penny higher than $3.80 I get less premium until $4.06
- $4.06 or higher - I have to make another sale at $4.06 against the Sep futures
- If that happens then I would “roll” this sale from the Sep to the Dec and likely collect another 13 cents of market premium. Resulting in a sale of $4.19 for new crop.
RESULT - I bought back the put for 41 cents and let the call expire worthless (saving on commissions). I lost 15 cents on this trade. While I'm disappointed that I lost money on this trade, it is the 10th straddle trade I made this year and the first time I lost money. I'm willing to accept a loss 1 of 10 times. Half of my loss on this options are offset by the trade above it. Profits from the following trade will need to be used to cover the remaining losses.
Previous Trade from 6/12/17
- Expected market direction - Probably sideways with some downside potential into fall
- Trade Detail - Sold Sep $3.90 call for 19 cents
- This trade amount = 5% of planned production
- Expires - 8/25/17 - after the crop condition is well known
- Potential Benefit - If Sep futures close at $3.90 or below on 8/25, I keep all of the 19 cent premium
- Potential Concern - no downside protection
- Every penny above $3.90 I get 1 cent less premium until $4.09 and I don’t have to sell any corn
- $4.09 or higher – I have to make another corn sale at $3.90 plus the 19 cent premium which would be like a $4.09 sale
- Because the sale would be against Sep futures I would have the opportunity to roll the sale forward and against the Dec futures which would likely add 10 cents of profit to the trade. Thus I could have a $4.19 sale in place.
RESULT - This option expired worthless. I keep 19 cents premium.
Previous Trade from 7/6
I sold a $3.90 Sep call for 15 cents on 10% of my '17 production.
What does this mean?
- If Sep corn is above $3.90 on 8/25 - I have to sell corn for $3.90 and keep 15 cents ($4.05 total). But then, I would “roll” this sale from Sep futures to Dec futures to capture another 12 cents giving me a sale at $4.17 on Dec futures.
- If Sep corn is below $3.90 on 8/25 - I keep the 15 cents to use on another trade in the future
RESULT - Obviously with futures below $3.90 I keep the 15 cents of premium
3 - New Trades - Selling Calls on 8/24/17
Last Thursday when Dec corn was $3.55 I sold the following calls for 10% of my production each
- Oct $3.55 call for 8.50 cents – expires Sep 22nd
- Nov $3.55 call for 11.25 cents – expires Oct 27th
- Dec $3.60 call for 11.50 cents – expires Nov 24th
What Does This Mean?
- If Dec corn is trading below $3.55 or $3.60 when these options expire - I keep the premium and add it to another trade down the road.
- If Dec corn is trading above $3.55 or $3.60 when these options expire - I have to sell corn for $3.55 or $3.60 PLUS the premium.
Worst case scenario for these trades, corn rallies above $3.55, stays there through harvest and fall, and I get an average price of $3.65 ($3.55 .10 cents option premium) for these three trades. Corn prices usually fall until harvest begins and then it slowly rebounds. Therefore, I think chances are good for keeping the premium on each trade and waiting for a rally down the road, but it's obviously not certain.
Do I want to sell $3.65 corn at this point? Not really. But then I ask, what happens if corn prices DON'T rally? I still have a substantial amount of grain unpriced that needs higher prices. So, if a rally doesn't come, I need to "manufacture" prices to get me to profitable levels.
The Danger In Buying Calls
Back in January many advisors told farmers to buy back any corn they sold in the form of calls. A commonly advised strategy was to sell grain when futures were $3.60-$3.70 against Mar futures, and then buy Sep $4 call for 20 cents.
Their strategy - if there was a drought or drought scare, farmers would get upside potential in the market and recover what they missed by selling early.
The following chart shows what happened (blue line represents the value of the Sep $4 call option).
Corn futures did rally 30 cents by mid-summer, but the call never rose above purchase price of 20 cents (green-dotted line). The only time a farmer would have made money on this call was in Feb (one month after buying) for a 7 cent profit. But, nobody who was working this strategy would have sold in Feb, because the strategy was to hold until summer and look for a weather scare.
Farmers who listened to this advice would have lost badly. Not only did they sell corn at low, unprofitable prices, but they ALSO lost another 20 cents for the purchase of the call. This is the 4th year in a row that this strategy didn’t work.
Farmers who buy calls, lose sight of the fact that they are ALWAYS going to have more corn to sell at an upcoming harvest. The farmers goal should have been to SELL at $4.20 not buy.
While I'm always hoping for a rally because I have more corn to sell,. I ALSO prepare for the possibility that the market doesn't rally. This strategy worked out in the trades above where I collected nearly 15 cents selling these Sep calls which will now be used on a future trade. So for instance, let's say corn rallies before Thanksgiving and I have to sell for $3.65 (the 3 new trades). Because of the previous 15 cent sold call that I get to add to a trade, I'll get $3.80 instead of $3.65, which is much better than what the market is offering today.
When grain farmers buy calls, they are speculating. It can be a low risk speculative trade with known limits of loss, but it's still speculative. Grain farmers always have more grain to sell, so re-owning grain is placing a bet that the market will be higher in the future. Grain farmers always have that bet on, because they are always producing more grain to sell. So, why add more risk?
Countless farmers have told me they never make money with options in the long run. That's probably because they are buying calls and buying calls limits farmers potential. Put another way, buying calls is like telling a baseball player to not swing at any strikes. While the player swinging at pitches outside of the strike zone may get a hit, it will be difficult and the chance of getting on base unlikely.
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