Significant carryout in corn and soybeans suggest ample inventory over the next year. Rally potential in the winter months will be limited. Therefore, to anticipate a major bull market over the next three months is betting against the high odds that rallies of 10 cents in corn and 25 cents in beans will not produce farmer selling. We do not think that is a good bet.
When it comes to summer, all bets are off. Weather is and will continue to be the dominant factor for price movement, not only this year, but in the foreseeable future. There seems to be a growing attitude that prices can never rally on weather again. Market grain assuming normal weather, but in any given year, weather can be anything but normal. Most farmers readily admit that just-in-time rains made all the difference in 2005. With high usage, attitudes for corn and bean prices can turn bullish in a hurry.
Producers need to initiate corn sales on 25% to 50% of expected production for 2006 between $2.45 and $2.75 December futures. In soybeans, sell between $6.00 and $6.75 November. When prices rally, farmers typically have less desire to sell, because, well, prices are rallying. On the other hand, having a disciplined strategy to sell as prices reach target points is likely the best way to manage downside risk and have a good average selling price. Helping to establish a strong, disciplined selling strategy is having CALL options purchased against sold grain. However, once prices do rally, CALL options become more expensive, and farmers have a tendency to shy away from buying them.
A strategy to consider is a calendar CALL option spread. This is where you buy or sell options on different months. Look to sell May CALL options one strike above the market. And at the same time, purchase one strike price out-of-the-money December corn CALLS. This strategy is designed to take advantage of time value erosion in the May CALL. In the last 90 days of an option's life, time value erodes rapidly. The May options have a high likelihood of expiring without value. If this happens, the December options are now fully in place for a weather market. Bottom line, we are attempting to cheapen the price of December corn CALLS by selling May corn CALLS.
A potential downside to this strategy is that, as prices rally, any gain on the December CALL could be upset by the loss in the May CALL. However, keep in mind that, as prices rally, your cash grain is gaining value as well. As trigger points are hit and corn is sold, then you need to take into account whether or not you want to hold the short May CALL. As a rule of thumb, if the May CALL doubles in value, use that as a point to exit. In order for this to happen, corn prices need to rally at least 10 to 15 cents, which gives you an opportunity to make solid cash sales based on December corn.
If you have questions or comments or would like this strategy explained and implemented for your operation, please contact Top Farmer at 1-800-TOP-FARM, ext. 129.