Another hurry up and wait day for our markets as we await
the USDA report out tomorrow.
When everything was said and done we had July corn up 3,
Sept corn down 2, December corn down 6, KC wheat down 4, MPLS wheat was down 12
on the July, MPLS September was unchanged, CBOT wheat was off 3 cents, July
soybeans were 14 higher, Nov beans down 1, US dollar about unchanged, gold down
29 bucks, crude up 1.25, and the DOW up 114 points.
Very wild day for the spreads today ahead of the
report. At one time MPLS July was up
12-13 cents only to close down 12 ½. Most
of the bids have long been moved to the September contract; but the price
action today on spreads was probably just a small preview of what the spreads
will do in terms of volatility as the USDA report comes out. It really seemed like a lot of bullish bets
have been placed the past few days which opens up the door to a potential buy
the rumor sell the fact.
Going into these type of potentially volatile reports a guy
wants to make sure that they are comfortable in their marketing plan. For some that might mean doing nothing; but
for others it might mean making a few catch up sales or getting some protection
in place.
Here are some various strategies that one might use. Just remember that no strategy is right for
everyone and for some doing nothing isn’t wrong either.
When you go into these reports you can look at thousands of
different strategies; but remember if you are buying options right before a major
report you are paying an inflated priced because usually implied volatility has
risen heading into the reports. So sometimes
you can buy an option right before a USDA report; get the direction right and
maybe even have the market move as much as expected only to see that option
value not move nearly as much as one might have hoped for. A lot of unknowns get answered in the reports
and as soon as those unknowns are answered some of the premium (volatility
premium) comes out in a hurry.
Bottom line before placing any of these trades make sure
that you understand them and are comfortable with the risks and rewards with
the various trades. Keep in mind that
futures and options are risky and not for everyone.
The below are hedge trades for those that feel they want
some sort of protection. Opposite type
of trades could be made for bullish bets; but producers probably should be
looking at hedging or protecting unsold inventory.
Hedge 1 – Simple purchase of a put. What strike and what month are the real
question. First off what are you trying
to protect? Old crop or new crop? Which one has the most risk? How much money do you want to spend and what
is the potential reward? For me if I am
going to buy a put to protect me from a train wreck from the USDA report I want
to be an August serial month; which follows the September board. Now if I am looking to protect from lower
prices via the weather continuing to be ideal that wouldn’t be the month I would
use.
But for just protecting the report I like using August
because I feel the most risk from the report is to the July contract followed
by the September and then December contract.
Bottom line is I want to distinguish where my risk is at
that I am trying to protect. In this
case I am just looking at report protection; nothing more.
So I personally go with the August option.
So hedge 1 is simply buying a 5.50 August Corn put for 12
cents. Why do I choose a 5.50 strike
instead of at the money 5.70 for 21 cents.
Here is where I look at the what if’s.
So if I want to protect a negative report; I want to protect a big
negative report. So I compare spending
12 cents for a 5.50 or 21 for a 5.70 and say what happens to these if the market
goes up; while that is easy they are both worthless in a hurry. If the market
goes sideways then the 5.70 out performs the 5.50. But what happens if a week from now September
corn is at 5.00 or 4.50. Not that I think
that will happen; but you have to ask yourself if the old crop story somehow
gets shut down via this report is weather going to help it find support???? Right now it doesn’t look like it.
So if we go to 5.00 on the September board would I be better
if I owned 5.70 puts or 5.50; while the answer is 5.70’s unless you spent an
equal amount of money on each of the strikes and in that case you would be much
better owning more of the 5.50 versus.
As example say you want to protect 100,000 bushels do you spend the 21
cents on 20 contracts or 21,000 buying the 5.70 strikes? Or for your $21,000 do you buy 35 contracts
at $600 bucks a piece or 12 cents a bushel?
If we go to 5.00 your 20 contracts of 5.70 would be worth $70,000; but
your 35 contracts of 5.50 puts would be worth $87,500. If we go to 4.50 the 20 contracts of 5.70
puts would be worth $120,000 but the 35 contracts of 5.50 would be worth $175,000.
So there is hedge 1; buying a put; as mentioned for above
reasons I like protecting where I think the most risk is from the report. Not where the most risk is from yields or
production (which won’t be updated in this report). Thus I think I would choose the 5.50 August
strikes.
Hedge 2 is buying the put and selling a call to pay for the put. Here is where things get interesting and more
complicated as via selling a call you open up the door for margin calls. So you could look at selling a 6.00 August
call; but personally I don’t think I would sell a call option against old crop
corn. So I would look to sell probably a
December corn call. What strike? There it depends on comfort and what your
bias is for the report. The biggest
home run and bank for your buck would be to sell an at the money corn call
(5.40) and use that to buy say 3 to 1 of the 5.50 August puts.
Take the same example above; if we have 5.00 corn and you did
this on 100,000 bushels; your put portion would be worth $150,000; and worth $300,000
at 4.50. But in exchange for this you
might have margin calls and you have capped your upside on 100,000 bushels of December
corn at 5.40. Plus even though the
trade is a free trade it does cost money to put it on. You get paid for the calls that you sold but
you have to margin them up and will continue to margin them up as the market
rises. But you also have to pay for the
5.50 August puts that you buy.
Hedge 3 would be similar to hedge 2; but instead of selling
the at the money corn call one sells the 6.50 Dec corn call and buys the 5.50
August put. Net cost being 1-2 cents;
but here again net cost; not net cash out of pocket. This gives you some protection 1 to 1 ratio
but doesn’t lock you into a corn HTA type of sale until we get to 6.50; know
don’t get me wrong you would have margin calls well before Dec corn got to 6.50;
but unless December corn is above 6.50 on November 22 you won’t have a short
futures position at some point.
Hedge 4 adds another twist and that is buying a put and then
selling one call and buying a higher strike call. For simple purposes we will say buy the
August 5.50 put sell the December 6.00 call and buy the December 6.50
call. Net cost is about a penny or
two. What this trade does is it caps the
margin requirement and gives you as a producer re-ownership above 6.50. So you have 1-1 protection below 5.50 basis
the September contract until 7-26 when the August put expires; as for the new
crop if December corn is below 6.00 you have nothing; if it is between
6.00-6.50 you have something similar to an HTA at 6.00 and if we go over 6.50
you start gaining again. Not a bad move;
a known cost.
Hedge 5 would be selling a call and use that money to buy a
put spread. In this example sell maybe a
December 6.00 call; buy a December 5.30 put and sell a December 4.70 put. Not sure that I like this trade; but many
would prefer to buy and sell options in the same strike month and not have the
calendar exposure. This would be more of
a new crop play. Cost on this trade
above is about 7 cents a bushel; it gives you a ceiling of 6.00 on your corn
while giving you 60 cents protection; for a cost of 7 bucks. The bad thing about this trade is the fact
that the 5.30-4.70 put spread won’t be at 100% value until December corn is
well below 4.70 or until options expire.
Via selling the put you have capped your protection and you won’t realize
near as much profit as hoped for should we fall; at least not nearly as fast as
one things because of how time value works.
Hedge 6 would be a calendar trade. As example some might look to buy an August
5.70 put and sell a September 5.30 put; net cost of about 8-9 cents. Easy to manage trade in many cases and the
thing it does is it lets gamma work for you.
The August 5.70 put will trade like a futures contract much sooner than a
5.30 September put. It is a good trade
that if managed properly can easily win more than 50% of the time; the problem
with it you just are never going to hit a home run.
Hedge 7 would be a different type of calendar trade; one
that the stock market guru’s use a little more.
Sell the 5.30 August put and buy the 5.30 September put; in this example
you are just trying to get longer protection and the most the trade can cost
you is what you spend on it. Or about 6
cents in this example. Hedge 6 has a
short option that will be out there after your long option expires; this is the
opposite. The difference is in this
trade you are buying and selling the same strike; in the above you have a
higher strike bought and a lower longer dated strike sold.
As you can see I think I could go on and on with various
trades. I am not saying that anyone
needs to have any trades on; after all they cost money and some of these ratio
strategies cost plenty in commission.
But you want to be comfortable in your marketing plan. Keep in mind that no one move is right for
everyone; as all of you have different risks and goals.
Please give us a call if there is anything we can do for
you.
Thanks
