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Sell and defend

12/30/2011 @ 1:02pm

Over the last two weeks, corn and soybean prices have moved higher on South American weather concerns. Now is not the time to be complacent. Weather developments in South America will likely dominate price movement for corn and beans in the months (and possibly the year) ahead. Historically, supplies are tight, both domestically and worldwide, especially for corn. Therefore, as weather goes and crop sizes change, the market will react.

So, how can you manage a weather market? You can consider the concept of sell and defend. This may be especially applicable for 2012. Firm basis, and now a recovery, should provide an opportunity to move old crop and begin selling new crop. However, you have to scenario plan and look ahead. What if weather in South America stays dry? What if weather concerns vanish overnight due to a change in the forecast? By selling and defending, you are selling into the cash market and taking advantage of strong basis and good prices, and then moving into a re-ownership strategy, preferably with fixed risk parameters. 

For 2012, December corn has been hovering near the $5.80 mark (as of this writing). Start making sales. If you want to hold off to see if prices move higher, have a trigger point under the market if the rally fails. If prices close under key support, then make a sale to either get started or add to sales already in place. Once sold, defend this position by purchasing either December call options or bull call spreads. Call options have unlimited potential, but will cost you quite a bit for time value. Yet, the beauty of call options is they give you great holding power. What this means is they have fixed risk and you need not concern yourself if the market makes dips or sells off. The key is time. You have plenty of time to capture weather markets either in South America or here in the U.S. As an example, if South America does receive adequate moisture and prices trend down, let’s say into May, you still have your call option in place. Now June rolls around, it turns dry in the U.S., and prices begin to race higher. Your call option comes back into play. If comparing this to owning futures, the likelihood is that you will use a stop to manage risk, and if prices trend down, could get you stopped out. Or emotion could take over when margin calls mount, and you step aside the market. With a bull call spread, you are entering a fixed risk strategy, buying an at-the-money call, and selling an out-of-the-money call to reduce cost. Your risk is fixed, as is profit potential.

There will be many factors that will move prices as the year ahead unfolds. However, by far the most dominant is weather. We can talk Europe, the economy, or other variables that will provide direction and add volatility. However, it still boils down to weather to determine if supply is significantly growing or shrinking. Therefore, perception of a supply change, large or small, will have prices moving in the opposite direction. Our best guess is that corn could trade $1.00 higher or $2.00 lower. Defend against lower prices and be prepared for higher prices, possibly much higher, should weather impact the size of the crop.

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