Free lunch?

Agriculture.com Staff 05/21/2010 @ 3:02pm

The old cliché that there is no free lunch is meant to point out that everything has a price. That is certainly true in marketing. Normally we make a sale and if the price goes up we are stuck with the price when the sale is made. If we use options there is premium to pay. An unusual situation in the current soybean market is a rare instance where there really is an almost free lunch.

Cash soybeans for immediate delivery at the processor in Council Bluffs were quoted at $9.54 after Thursday's close. That reflects a basis of ten cents over July futures. At the same time August futures closed at $9.35, or 19 cents under the current cash bid. With the negative carry between July futures and August or September futures, it may be possible to buy a call spread that would make you long soybeans for most of the summer with little actual premium cost. For instance, buying a $9.40 call and selling a $10 call would result in a net premium cost of 17 cents, less commissions. The spread between the cash soybean bid and the August futures would more than pay for the premium.

A possible glitch to this strategy is that trading is thin in some options and it may not be possible to implement the strategy exactly as I have described. Another down side is that August futures might not go up as fast as the cash bids if there is a big rally in the near future. The big upside of the strategy is that the cash return is locked in if soybean prices drop. This is a way to take advantage of the current cash price at a very low cost and with little down side risk.

A similar situation occurred in the soybean market in late 2003. In that case the inverted price structure foretold a big bull market later in the winter. An inverted market is sometimes a predictor of better prices ahead. In 2003 the best strategy was simply to hold cash soybeans in storage. The timing this year is different with a big crop in the process of being planted. It is doubtful that there will be a rally as large as the one in 2003 unless there are weather problems this summer.

Inverted markets indicate good demand. The one this time probably means that most farmers have sold last year’s production so end users have to raise the basis to pry the last bushels of beans out of farmers’ hands. The situation could change quickly. For those individuals who still own beans, it is a rare opportunity to get a free lunch!

The old cliché that there is no free lunch is meant to point out that everything has a price. That is certainly true in marketing. Normally we make a sale and if the price goes up we are stuck with the price when the sale is made. If we use options there is premium to pay. An unusual situation in the current soybean market is a rare instance where there really is an almost free lunch.

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