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Bouncing back from a worst case marketing scenario

While it’s a new year, there is nothing new for corn prices. A sideways market for the next three months seems likely.

There are indications that farmers would be willing to start selling as futures approach $3.60 to $3.70, but many seem to be refusing to sell below $3.50. On the flip side, end users indicate they don’t have much coverage and will buy during any market dips.

Bean prices are now largely driven by rain in South America. As the South American mid-summer approaches, they have had perfect growing conditions so far; however, mid-February is when moisture levels are most critical. Add to that, exports here are not pacing as planned to meet USDA estimates, and higher prices than the current upper $9s might be difficult.

 

Options — Straddle — Beans

As a part of my marketing strategy, I always understand all possible outcomes of each trade I do, and I make sure I’m willing to accept all potential scenarios. Unfortunately, the following bean trade example illustrates that despite careful planning and doing trades that align with historical trends to maximize profitability, the worst case scenario can sometimes happen.

It’s not a big surprise that this happened in beans. Bean prices compared to corn are usually more volatile and unpredictable. Some of this is due to 60% of the world’s bean supply being produced in South America. Still I think that it’s important to be fully transparent, not only for credibility reasons, but also because there is a lot to learn in worst case scenarios for the next time I place a trade.

When developing my market plan and strategy I always write down for each trade the detail and rationale for why I placed it and all possible outcomes. Then when reviewing the trade later I can remember my mindset at the time. Following shows the trade detail and rationale for why I placed this trade two months ago, as well as the results and current situation.

On 10/27/17 I was 100% sold for my 2017 crop when Jan futures were trading at $9.85. I sold a $10.20 straddle for 45 cents (sold a $10.20 put and a $10.20 call for a total of 45 cents premium) against 20% of my ’17 production. Note, any additional sale over 100% of 2017 production will be moved to 2018 production.

  • Trade expired12/22/17
  • Expected market direction for the next two months: When analyzing historical trends, South America usually has a weather concern between 10/27 and 12/22, which causes bean prices, already low during the U.S. harvest, to bounce off the bottom and rally.
  • Potential Benefit: If Jan futures close at $10.20 on 12/22/17, I keep the 45-cent premium to add to my sales average.
  • Potential concern: Reduced or no premium if the market moves significantly in either direction.
  • For every penny lower than $10.20 I get less premium until $9.75 At $9.75 or lower the $9.80 sale I had in place will be wiped away, but any profits gained on that trade and from market carry will still remain, which probably will be at most 15 cents in total profit.
  • For every penny higher than $10.20 I get less premium until $10.65 At $10.65 or higher, I have to make an additional bean sale at $10.65 against Jan futures.

I would be most profitable on this trade if beans had rallied some by 12/22/17. Historically, the market usually rallies during this time period because South America almost always has a weather concern somewhere. I wanted to take advantage of this high likelihood and maximize my profit potential, hence I did this trade. While I was willing to accept the outcome if prices went below $9.75, it seemed unlikely because it basically required perfect weather throughout all of South America, which would be quite a rare event.

 

What happened?

There WAS perfect weather during this time period throughout South America and Jan futures were trading below $9.75 on 12/22/17. Therefore, the sold call portion of the straddle expired worthless and I let the sold $10.20 put get exercised, which means I’m now long a $10.20 futures position against Jan futures. However, I still have the 45-cent premium I collected from the trade, which means it’s like I had to buy beans for $9.75 ($10.20 less the 45 cent straddle premium). Obviously, in hindsight I’m disappointed with this trade.

So, on 12/26/17 I rolled this long position to March futures. Since March futures were 11.5 cents higher due to market carry than Jan futures at the time, it meant re-owning some beans for $9.865 (9.75 + 11.5 cent carry) after commissions against the March futures. When I’m long futures and I have to roll forward it means I have to sell out the Jan futures and buy back the higher March futures. Selling low and buying high is NOT a successful business plan long term. So, now I’ll need something to help the market rally to sell these beans back out just to breakeven on this trade.

On the surface one might think this was just a bad trade, but that wasn’t the problem. There was a lot of rationale based upon historical trends to place this trade and there was even some risk management built in to minimize losses (i.e. I would not have lost money even if the market had remained sideways). The problem: I was overly bullish beans when an unlikely and uncommon event pushed the market lower.

With some hindsight, I could have still sold the straddle, but I should have picked a lower strike price — like one where futures were on the day I placed the trade instead of going for a higher value. Had I picked $9.80 instead of $10.20, I would have made 10 cents instead of being out 30 cents when this trade expired and now hoping for a market rally to get me back to breakeven.

 

Bean position

So with the removal of a previous sale due to the straddle, here is my current bean position:

POSITION – BEANS 2017 2018
Beans Sold – Futures

80%

0%

CBOT Price

$9.80 est.

Market Carry

$0.10

Final hedge price $9.90 est.  
Basis on Farm (Beatrice, NE)

($0.70)

Final Cash Price on Farm $9.20 est.  

 

This example illustrates why I’m usually not a fan of grain re-ownership and why I limit it within my grain marketing plan. All too often it adds more risk and potentially lowers profits. Now granted, re-ownership was the worst case scenario of this trade, I knew it was a possibility when I placed the trade and historically a market drop during this time frame was unlikely. Still, I’m disappointed. In this case, not on the trade but the selected strike price. I should have been a little less greedy, and a little less bullish.

It’s impossible for farmers to market their grain perfectly all the time. The lesson from above is not to avoid complicated marketing strategies or alternative opportunities when one doesn’t work as hoped. Instead, farmers need to review each trade, understand what they did wrong and learn from their mistakes to try and help themselves stay as profitable as possible year after year.

 

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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