The recent break in the grain markets has had my phone ringing with producers and speculators alike, clamoring for a plan to handle what they perceive to be a confusing market. For the first time in two months, I could feel some panic coming from those who are long the markets. Many are fretting they are going to let these prices slip through their fingers, while in the same breath they talk of wanting to participate in the next rally, whenever that may come. I think the last sentence does a good job of explaining the plight of the producer on days like today. They don’t want to take losses waiting for the next rally. Who knows, maybe it will never come?
The good news is that you CAN have your cake and eat it too. You can get away from the mountain of selling pressure grains have been under the last week, along with having the ability to make money from a rally back above 8.00 should it happen sooner or later. The strategy is simpler than one would think. It only consists of two steps:
Step 1: Sell whatever cash grain with which you are comfortable selling. Do whatever you feel is necessary to not be oversold. Keep in mind we plan to re-own the bushels sold, so unless you plan to store because of the expectations of basis improvement, I would look to get rid of as much product as you see fit. I dont see much of a basis improvment before the end of the harvest. For those who don’t store or cannot store their grain, this strategy should be strongly considered.
Step 2: We want to renown the equal amount of bushels sold in step 1, in the March or May Contract using call option spreads. This accomplishes two goals:
- It removes you from any downside risk on your cash bushels. The only risk will remain with what premium you pay for the call spreads.
- It buys you time, to allow the market to turn around. The last four years, we have seen significant price pressure in the fall. Recently that pressure has been relieved around the first of the year. This year, I think the buying could start sooner, because South America is under more pressure to have a flawless growing season. By owning March or May call spreads, you will be a participant in the South American weather rallies. This is important. I don’t believe there is anything out there that is as potentially bullish as a South American production scare. I don’t see prices getting over recent highs without a production hiccup from Brazil/Argentina. But with all of the moving parts their planting, harvest and transport entails, there is a lot of room for failure.
I would look to spend approximately 35 cents. Whatever you spend will be you max risk (plus fees). If you do this trade and nothing else, you can’t lose more than you will pay out for the position nor will you ever get a margin call. Your risk is fixed. Prices in corn have fallen more than 35 cents in the last two days. For that same amount this strategy can provide length in the markets for more than 200 days. This will help with any seller’s remorse you may have.
Strategy example
Bill is a corn farmer. He has 10 K bushels of production left to sell for the year. He does not have nor does he wish to pay to store the corn. Bill is looking to have some cake and eat it too. He calls his elevator and makes a cash sale on his corn for the price on the board of 745 on the Dec delivery contract (for this example, the basis was 0). Simultaneously Bill buys the 750 May Call and sells the 880 May call for 35 cents (May corn was trading at 748). For those new to call spreads, what this buys Bill is the right to be long corn from 750 and then providing someone else the right to own those bushels at 880. Basically it buys him 1.30 of upside exposure in the Corn market. The cost of 35 cents, subtracted from the difference in the strike prices (1.30) gives Bill a maximum profit potential of 95 cents (before fees) for his renowned bushels. If the price of corn in May is below 750, then he loses his 35 cents. Anywhere over 880 and he makes his max profit.
The best part about this strategy is that he can sit back and let the market do its thing. He doesn’t have to fret as the market falls (remember, he sold his grain) and can still keep on his “Bulls” jersey for the next 6 months with no worry of a margin call.
Please call with any questions on this strategy and how it can be applied to fit your needs.
STRATEGIES USING COMBINATIONS OF POSITIONS, SUCH AS SPREAD AND STRADDLE POSITIONS MAY BE AS RISKY AS TAKING A SIMPLE LONG OR SHORT POSITION.
YOU SHOULD BE AWARE THAT IN THE EVENT YOU LIQUIDATED THE LONG SIDE OF A BULL CALL SPREAD AND STILL MAINTAINED THE SHORT OPTION POSITION, THEN YOUR RISK WOULD BE UNLIMITED.
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