The market was surprised last week when the USDA increased corn acre planting estimates by 1 million. The USDA also indicated that stocks may be higher than the market was anticipating. These adjustments could really hurt the chances of a major corn rally for the rest of the year. At this point, it will take a major weather-related event in July for any substantial rally in the long-term. And, the window for a weather-related event is narrowing, usually after July 4th there is less potential left. Some weather forecasts indicate there is a possibility for hot and dry weather in the western Corn Belt, but it will need to be significant for any fireworks in the next few weeks.
Actual crop conditions are seemingly subjective based upon perspective. Bulls say crop conditions this year compared to last year are much lower. Bears say there is still too much old crop corn in storage and will help the market withstand a decrease in reduced yields. With Dec corn hovering around $3.90, it’s likely the market will remain range-bound for another month. This range is frustrating because it is lower than most farmers’ breakeven points. On one hand, $4.20 corn is unlikely without a weather scare. On the other, until ear sizes and weather during pollination are known, trading below $3.60 is also unlikely. Longer term if stocks have increased without a pickup in demand and IF weather is normal even a yield of 165 might not be enough to keep corn from testing the lows of last year.
Soybeans acres were not quite as high as the market was looking for in the latest report. There was also a slight reduction in stocks. The key now will be late July and August weather. The market knows that August weather makes or breaks the soybean crop. There is a wide range in potential prices for soybeans yet this marketing year — $8 or $11 are both still possible.
Late June (6/23/17) was the expiration of July options. Following are the results of a trade I made back in the winter.
- On 1/27/17 July corn was Trading $3.75
- Expected market direction into summer was probably sideways with some upside potential into early summer.
- On 1/27/17 I sold July $3.90 straddle for 43 cents with an expiration on 6/23/17, right when there is the best chance for a weather rally
- Potential benefit: If July futures close at $3.90 on 6/23, I keep the 43 cent premium
- Potential concern: Reduced or no premium if the market moves significantly. For every penny lower than $3.90 I get less premium until $3.47. At $3.47 or lower an original corn sale would be removed, but I keep the 43 cents above to be added to another sale and I collect another 20 cents of carry premium to this point. Every penny higher than $3.90 I get less premium until $4.33. At $4.33 or higher, I have to make another sale at $4.33 and my $3.90 sale is stalled at $3.90.
July corn was trading at $3.59 on June 23 after dropping for six straight days. I thought there was a chance for a Monday rally, so I let the puts get exercised. This turned the trade into a long corn position (i.e. in theory I was buying corn) at $3.90 on the July. It’s important to remember that I will still collect 43 cents of premium from the straddle trade. I sold my long position back for $3.60. So, I lost 30 cents on the futures side of the trade, but made 43 cents from the straddle sale. The final result was a net of 13 cents premium.
Why did you let the options make you long (i.e. buy) corn?
I had only 12 cents of profit left in the trade with the futures at $3.59. I decided to risk the 12-cent profit potential I had left in the trade to try and make more. I made the right choice, but not by much (1 extra cent). I didn’t want to take any additional risk with a long position through the USDA report. Obviously with some hindsight today it looks like I should have waited. However I’m not bothered by the miss because I still turned a profit on this trade.
As a corn producer I rarely can justify buying corn futures for any length of time. Usually it’s a speculative play, which I always try to avoid. While I will admit this trade was speculative, in my opinion after six days of decreasing prices it seemed reasonable that the market had dropped to the bottom of the recent trading range, meaning I was willing to accept a little extra risk for the chance at additional profit potential. I was prepared to sell my long corn position out if the market was down, even if that resulted in less profit. Fortunately it didn’t lose me any money to wait a couple days.
More trades placed
Unless there is a major weather-related event, I expect sideways trading to continue. Considering my recent success with straddles, I made another straddle trade the previous week.
- On 6/20/17 Sep corn was trading near $3.80 with the expected market direction into late July probably sideways with a potential slight dip in prices
- Sold Aug $3.75 straddle for 25 cents that expires 7/21/17 before yield is known and while there is still a chance for a weather rally
- Potential benefit: if Sep futures close at $3.75 on 7/21, I keep the 25 cent premium
- Potential concern: Reduced or no premium if the market moves significantly. For every penny lower than $3.75 I get less premium until $3.50. At $3.50 or lower an original corn sale is removed. For every penny above $3.75 I get less premium until $4. At $4 or higher, I have to make another sale at $4 against the Sep futures. At this point I still have some old crop I need to sell and $4 seems like a great goal.
Typically the corn market tends to decrease from the third week of June through July. Therefore, I made an additional trade to capture that potential. On 6/20 when Sep futures were around $3.80 I sold a $3.90 Aug call for 9.5 cents on 5% of my ’16 corn production.
What does this mean?
- If Sep corn is above $3.90 on 7/21 I have to sell corn for $3.90 and keep 9.5 cents ($3.995 total).
- If Sep corn is below $3.90 on 7/21 I keep the 9.5 cents to use on another trade in the future.
I’m happy with this trade. I need to sell the last of my 2016 production, and while I hope futures rally, $4+ will be difficult. Even if it happens, most farmers will sell at those values, therefore it might not last long. Either way I keep 9.5 cents on this trade. The only downside would be a significant drop in prices (since there isn’t any downside protection on this trade), but that wasn’t the goal of this trade.
Selling hope and time
Often some “experts” in the industry suggest that farmers should “look for a possible re-ownership opportunity.” This “advice” doesn’t make any sense to me. When farmers have unpriced grain in storage or the field growing, they already have ownership. They don’t need MORE corn while prices are low, they need the market to rally so they can sell the corn they have or will have. More corn only adds more risk to their farm operation. In essence, this advice is telling farmers, who are already speculators, to double down.
In January many experts suggested, when July futures were around $3.70, that farmers buy $3.70 July calls for 20 cents or $4 July calls for 10 cents. Let’s take a look at the realities of this advice to farmers. The chart above shows July corn futures (Dec to present).
In both cases, there was little opportunity for farmers to make any profit buying calls as the experts recommended. The only way farmers would have profited was if they had exited their position in Feb (even then the profit was small).
The thing is, very few (if any) farmers would have done this. The whole point of buying the calls was to hold them, expecting a weather event in late spring/early summer to spark a rally. For most of the farmers that did this, the calls expired worthless or nearly worthless and they were out the call costs (10 or 20 cents). That took a disappointing sale back in the winter and turned it into an even more depressing sale after factoring a loss on the option.
This is why I stress to farmers to really think about what they are doing when they speculate by BUYING calls. Right now almost all farmers have some 2016 crop left to sell and most of the 2017. So, it almost never makes sense to buy the right to buy more corn if you are a farmer who is hedging.
(Note, in my straddle trade above I was able to stretch a small profit by selling options and collecting 13 cents of premium verses farmers who bought calls and likely lost 10 to 20 cents. That is could have been a difference of 23 to 33 cents to the bottom line.
In most cases, farmers buy calls because they HOPE the market will go up. In truth, I’ve seen very few times when farmers have made a lot of money buying calls. Most of the time they are lucky to make a profit and many times they lose some or all of the premium they paid.
My marketing plan does not include “buying hope,” but instead I “sell hope.” Certainly not on all of my bushels, but I do for some. Basically, I get paid for selling hope to somebody else.
Farmers need to remember that 66% of the time it will be a normal year. During normal years, prices well above breakeven points are unlikely for an extended period of time. I try to position my marketing strategies where I can take advantage of opportunities assuming trend line expectations while understanding how I will be affected by unpredictable market variations.
When buying options the longer length of time until the option expires makes it worth more. More time equals more chances for market movement.
Similar to hope, I don’t want to buy time. It’s expensive because it’s in finite supply and everyone wants more of it. Instead I determine what price I want, then I optimize how much (time) value I can get for that option and then I sell it.
Think about your goals
I always caution farmers to think about their end goals in marketing. What happens if your goals aren’t met? What happens if the price doesn’t go up like you think or hope it should? What happens if you are wrong? Are you prepared for all market scenarios?
My goal is to design a marketing plan that takes into consideration as many market scenarios as possible. In every trade I analyze how my profit will be affected if the market goes up, down or sideways. I then take into consideration risk and the likelihood of each scenario happening based upon current market conditions. While I’m prepared if the market goes down or sideways, like all farmers, I ALWAYS want prices to go up. Ideally the trades I made today are wrong if the market rallies. And if it does, I’ll sell more corn because I will ALWAYS have more corn to sell. Maybe not in 2017, but certainly in 2018 and 2019.
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.
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