Analyst Weighs Fall Market Strategy
As the grain markets factor in this year’s crop size and prices find their footing, there are different scenarios that could occur. Perhaps the most likely is a continuation of a sideways trend, particularly in the corn market where prices have been range-bound for well over a year. As fall approaches and expectations for harvest pressure to push prices lower prevail, the market may be trying to find its bottom in the near future. Expectations for a recovery in price after harvest is likely correct. However, to date, the USDA is suggesting that this year’s corn crop is close in size to expectations, which is trendline yield of 170.7 bushels per acre. This month’s Supply and Demand report indicated a yield expectation of 169.5 bushels per acre.
To the disappointment of producers, prices moved very little last fall and winter. With projected carryout similar to last season, this same price pattern may occur this fall and winter. How does a producer take advantage of this type of market? For those who store grain, typically the idea is to be patient and wait for harvest inventories to be chewed through. Ultimately, prices will need to move higher to pull corn out of producers’ hands. Therefore, doing nothing and being patient is a strategy which historically has had merit. However, prices may rally some, then falter, and continue to trend sideways for the next three or four months. The strategy to wait may not pay dividends unless your timing to sell is near perfect.
Farmers typically do not sell on small rallies, especially if they just put the crop in the bin. How can you add value in that environment? Consider the strangle strategy in options. A strangle is when you are either buying or selling out-of-the-money calls and puts. We like the selling strategy, which means you are the writer of options. You collect the premium as an option writer and, over time, due to the way options are structured, they may gradually lose value. As a collector of this premium, you are attempting to add value to your crop in storage.
Here’s an example: As of this writing, March $4.00 corn calls are trading near 11¢ and March $3.60 corn puts are near 12¢. If March corn futures finished on expiration day (February 23) between these two strike prices, both options would lose value. The premium collected is yours (less commission and fees). Now let’s say prices rally. You still collect premium (less commission and fees) on both options, and you need to be willing to accept the short futures at $4.00 (the call converted into a futures). With premium collected, your breakeven price is over $4.20, which (as of the writing of this Perspective) would indicate an increased value of 46¢ on the March futures contract, or over a 12% increase in the value of your unpriced crop (assuming there is no change in basis). Should prices move lower, you’ll be assigned a long futures position at expiration of $3.60 March. You still collect the premium, which would suggest a breakeven under $3.40. Given the current supply and demand picture, owning March futures at less than $3.40 is likely a good place to be long futures, as the market has spent very little time over the last four years trading under $3.40.
While this strategy is not for everyone, it is an attempt to add value to your crop. We can also rationalize this position from the perspective that you’ll hedge unpriced corn at a higher level, reown sold corn at a lower level, or collect premium should prices remain range-bound. When you sell options, you have unlimited risk. Shorting options is also a marginable position. You need to be prepared for this. As with any strategy, make sure you have a clear understanding and be aware of ramifications should markets move more than you might expect. In challenging financial times, it is important to avoid undue risk. It is also important to explore potential opportunities as you scratch and claw for every advantage you can find.
If you have questions or comments, contact Top Farmer at 1-800-TOPFARM, ext. 129.
Futures trading is not for everyone. The risk of loss in trading is substantial. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Past performance is not necessarily indicative of future results.