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No Room in the Bin
This time of year we give thanks for our blessings. We can also add uber-bountiful harvest yields to that list! When speaking with clients the past few weeks we have consistently heard, “Well, we have a bumper crop, and we had to take the extra bushels that won’t fit in our bins at home to the local elevator to sell. I have sold those extra bushels, and now I want to reown them in case the price of corn goes higher in 2017. How does that work? Will it mean possible margin calls? And, what is the cost?”
While we can use many different strategies to reown corn this year, many of our clients are telling us they are not interested in the possibility of margin calls. Nor, do they want to spend a lot of money on reowning corn. That’s OK. Some are also a little leery as to how high the price of corn could go in 2017 due to enormous ending stocks that are here in the U.S. and around the world.
These are the fundamental reasons corn prices could go higher in 2017:
- Planted U.S. corn acres are already expected to be lower in 2017.
- We are just beginning the South American growing season, and La Niña is hovering (hot and dry growing conditions) in the forecast.
- China is desperately trying to use up that nasty corn from four years ago (and their end users are balking at the idea of it). To top it off, they are now mandating E-10 in six of their provinces, which ultimately means more demand for corn down the road.
- Brazil is OUT of corn to export, and the U.S. is the ONLY game in town until the South American harvest.
- PLUS, even though corn carryout is record large, the stocks-to-use ratio tells a friendlier story. This ratio indicates the level of carryover stock for any given commodity as a percentage of the total use of the commodity.
Bull Call Spread
So which strategy should we use knowing that many producers are telling us they’re not interested in the possibility of margin calls, nor do they want to spend a lot of money on reowning corn? Let’s focus on one for today. Introducing the bull call spread.
The bull call spread is an option trading strategy that can be used when the user thinks the price of corn may go up moderately in the near-term.
A bull call spread is the simultaneous purchase of a lower strike price call and selling of a higher strike price call with the same month and underlying futures. This is also sometimes referred to as a vertical spread. The purpose of a bull call spread is to reduce out-of-pocket expense. It’s used when you have an expectation that prices will rise but not above the strike price of the sold call. Please note that by selling the out-of-the-money call, the trader reduces the cost of establishing the bullish position but forgoes the chance of making a large profit in the event that the underlying asset price skyrockets. So, the benefit is that the bull call spread is cheaper and has no margin calls. However, it limits the rate of return if the market really rallies.
As an example, if you think that corn futures will rally at some point in 2017, and you are very well aware that for the past two years, corn futures have had a hard time rallying past the $4.50 price point, which is now considered overhead resistance, a bull call spread you could consider is: December 2017 corn is (at the time of this writing) trading at $3.80, and you believe that sometime in 2017 corn futures have the ability to possibly rally to $4.50, but maybe not beyond that, barring a drought. You could buy a December 2017 $3.80 call and at the same time, sell the December 2017 $4.50 call. This action done together creates the bull call spread.
As of this writing, the December 2017 $3.80 call costs 31¢, and then, by selling the December 2017 $4.50 call, you collect 13¢ of option premium. The net cost to you is then 31¢ – 13¢ = 18¢, plus commission and fees. This covers 5,000 bushels.
Your proﬁt potential is ﬁxed at the difference of the strike prices ($3.80 to the $4.50 area) so a 70¢ range less cost of the option strategy. In this example, 70¢ less 18¢ or 52¢ of potential maximum profit, less commission and associated fees. The exchange views this position as a ﬁxed-risk position. Therefore, there is no margin requirement or margin calls, other than the 18¢ of cost plus commission and fees.
If you have questions, you can reach Naomi at email@example.com.
The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Neither the information presented, nor any opinions expressed constitute a solicitation of the purchase or sale of any commodity. Those individuals acting on this information are responsible for their own actions. Commodity trading may not be suitable for all recipients of this report. Futures trading involves risk of loss and should be carefully considered before investing. Past performance may not be indicative of future results. Any reproduction, republication or other use of the information and thoughts expressed herein, without the express written permission of Stewart-Peterson Inc., is strictly prohibited. Copyright 2016 Stewart-Peterson Inc. All rights reserved.z