Managing a sideways market with downside protection

Weather is driving the market right now. As forecasts adjust twice a day, the market can shift direction abruptly. At this point it’s really difficult for the market to fully estimate the actual amount of stress the corn crop has sustained so far and its impact on overall future yields. Contributing to the uncertainty is the significant amount of unpriced old crop corn still in storage by many farmers, which will continue to put resistance on higher prices in the short-term.

 

Market action

Uncertain about the market direction going into summer, and with less corn than I desired to have sold for the 2017 crop, I want to make another trade. With what I know today, I expect the market to be trading sideways from here until late in November.

 

New trades I placed:

6/12/17 — Trade #1 when Sep corn futures were $3.89

  • Expected market direction — Probably sideways with some downside potential into fall
  • Trade Detail — Sold Sep $3.90 call for 19 cents
  • This trade amount = 5% of planned production
  • Expires  8/25/17 after the crop condition is well known
  • Potential Benefit: If Sep futures close at $3.90 or below on 8/25, I keep all of the 19 cent premium
  • Potential Concern: no downside protection

For every penny above $3.90 I get 1 cent less premium until $4.09 and I don’t have to sell any corn. At $4.09 or higher I have to make another corn sale at $3.90 plus the 19 cent premium which would be like a $4.09 sale. Because the sale would be against Sep futures I would have the opportunity to roll the sale forward and against the Dec futures which would likely add 10 cents of profit to the trade. Thus I could have a $4.19 sale in place.

6/7/17 – Trade #2 when Dec corn futures were $4

  • Sold 2 Dec 4.00 calls and collected 29 cents each (or 58 cents total)
  • Bought 1 Dec 3.70 put and paid 11 cents
  • Net profit: +45 cents (after paying just under 2 cents of commissions)
  • All trades expire the day after Thanksgiving
  • This trade amount = 5% of planned production is protected to the downside

 

What does this mean?

Basically I have a floor price of $4.15 and a potential price ceiling of $4.45, but the outcome varies depending on the price of Dec corn at option expiration (which is the Friday after Thanksgiving).

  • If Dec corn is near $4.20 at expiration I get about $4.20 for my corn

• Every penny corn is below $4.22 to $4.00, 1 additional cent is added on to the $4.20 price (e.g. if it is $4 exactly I take home $4.45)

• Every penny corn is below $4.00 to $3.70, 1 cent is subtracted from $4.45 all the way down to $4.15 (if it is at $3.70)

• Anywhere under $3.70, and I still get $4.15 (15 cents above where the market was when I placed the trade)

  • If Dec corn is above $4.22 then I have to take $4.22 on the this sale and I have to make another corn sale at $4.22 (even if corn is $4.50 or $5)

Here is graph illustrating the results of trade #2

scheve graph June

Seems like a great trade, why not do more?

This trade required me to do something that I normally caution against and that is to risk having to sell two bushels to protect one bushel from downside. So while there is still the potential of doubling up a 2017 sale at $4.22, I don’t want to commitment more than a max of 10% of my anticipated production right now.

 

Trade summary

The bottom line is this is a sideways market trade play with some downside protection.

  • Market trades sideways = biggest profit (the closer the market is to $4, the better)
  • If the market goes up I get a premium that puts me on my farm’s breakeven points or better
  • If the market goes down I have a $4.15 floor price
  • If there is a horrible drought I miss out a on a huge price rally, but I have much more of my crop left to sell.

As I’ve mentioned before, I plan my grain marketing on what I think might happen based upon what I know today and historical trends. However, I still consider all possible scenarios the market could do. The market can do three things: go up, go down, or go sideways. So when making trades I need to be comfortable with all outcomes. That’s why I always balance potential premiums on each trade against the risk I’m taking if the market goes a different direction.

Jon grew up raising corn and soybeans on a farm near Beatrice, NE. Upon graduation from The University of Nebraska in Lincoln, he became a grain merchandiser and has been trading corn, soybeans and other grains for the last 18 years, building relationships with end-users in the process. After successfully marketing his father’s grain and getting his MBA, 10 years ago he started helping farmer clients market their grain based upon his principals of farmer education, reducing risk, understanding storage potential and using basis strategy to maximize individual farm operation profits. A big believer in farmer education of futures trading, Jon writes a weekly commentary to farmers interested in learning more and growing their farm operations.

Trading of futures, options, swaps and other derivatives is risky and is not suitable for all persons. All of these investment products are leveraged, and you can lose more than your initial deposit. Each investment product is offered only to and from jurisdictions where solicitation and sale are lawful, and in accordance with applicable laws and regulations in such jurisdiction. The information provided here should not be relied upon as a substitute for independent research before making your investment decisions. Superior Feed Ingredients, LLC is merely providing this information for your general information and the information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision. The contents of this communication and any attachments are for informational purposes only and under no circumstances should they be construed as an offer to buy or sell, or a solicitation to buy or sell any future, option, swap or other derivative. The sources for the information and any opinions in this communication are believed to be reliable, but Superior Feed Ingredients, LLC does not warrant or guarantee the accuracy of such information or opinions. Superior Feed Ingredients, LLC and its principals and employees may take positions different from any positions described in this communication. Past results are not necessarily indicative of future results. He can be contacted at jon@superiorfeed.com.

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