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Drought drives traders to seek shelter

07/16/2012 @ 4:18pm

With Midwest drought conditions worsening, investors feeling the heat are seeking protection from rising corn prices.

Buying bearish options on Tyson Foods Inc. (TSN) and Smithfield Foods Inc. (SFD)--whose animals feast on corn--was one way of doing so.

Traders snapped up protective put options on packaged-meat producers that are especially sensitive to the price of corn feed. Activity suggests traders fear continued weakness in the shares as the corn-crop situation becomes more precarious.

One trader in poultry packager Tyson Foods' options picked up about 1,000 August $16 put options for 70 cents a share in a trade WhatsTrading.com analyst Frederic Ruffy called a hedge against further losses by the downtrodden shares.

"The pressure of high feed costs is putting pressure on the poultry producers," Mr. Ruffy said.

The Tyson Foods puts grant the buyer the right to sell shares at $16 over the next five weeks. Though shares were below that mark Monday afternoon, after factoring in the price paid for the position, the options protect against a stock-price drop of more than 2.1% over that period.

Tyson Foods shares slid 52 cents, or 3.2%, to $15.63 Monday, extending a 10-session losing streak that has shaved 17% off the stock's value.

Meanwhile, another trader bought about 2,000 August $18 put options on Smithfield Foods, a producer of packaged pork products, for 75 cents a share in a similar hedge. This protected the investor against a drop of 5.2% from Monday's closing price.

Smithfield shares dropped 71 cents, or 3.8%, to $18.19 Monday, off 16% since the end of June.

"The reason why all these puts are being bought is because feed is primarily made of corn," said Mark Sebastian, chief operating officer at Chicago-based consulting firm OptionPit. "It is going to have a big negative effect on costs and crush [company] earnings."

U.S. corn futures traded sharply higher Monday amid continued worries about widespread drought shrinking the size of the U.S. crop. Prices on futures for September delivery settled up 4.9% at $7.77 a bushel, adding 41% over the past three weeks.

High temperatures and drought are expected to continue across the Midwest, from Kansas and Nebraska to Illinois and Indiana, and no significant rain is expected this week.

"It's toast. Everything is toast," Mr. Sebastian said of the corn and soy crops. "There should be protective put buying. The packaged-food producers are going to get crushed."

The U.S. Department of Agriculture reported at 4 p.m. EDT Monday that the situation has continued to deteriorate, with the percentage of the corn crop deemed to be in "good" or "excellent" condition dropping to 31%, which is down from 63% a month ago.

Tyson Food options have seen elevated volume for six of the past nine sessions, with activity reaching more than four times the 22-day moving average Monday. Smithfield activity hasn't been as intense, seeing elevated volume just three times in the past nine sessions. Trading in Smithfield options jumped to 3.7 times the average Monday.

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