Last week’s USDA report showed an increase of just over one bushel per acre in the average yield to 176.6 bushels per acre. Despite a slight decrease in the harvested acres in the report, there will likely need to be a supply disruption sometime in the next eight months for a significant rally to happen. It will probably need to be either a weather issue in Brazil over the next three months or in the U.S. this summer. Even a two million acre decrease in planted corn acres won’t likely be enough to get nearby corn back above $4 at this point. It will take five bushels below trend line yields too.
There is considerable fear that corn could slide down further over the next few months. While I think corn could test $3.30, I doubt farmers will sell that low which might help keep prices from staying at those values for long. Therefore, I’m looking for corn to be range bound between $3.45 to $3.55 until the end of March.
Bean yields, on the other hand, were reduced slightly. The market was expecting a slight increase, so there was some fund buying late Friday. Fundamentally there is little reason for bean prices to go up. The USDA report also showed a decrease in export demand, global supply is high and Brazil is on track to produce a record crop. It seems a small production issue is necessary for a bean rally as well.
However, there was a similar situation two years ago when everyone thought $8 was likely at this point in the year, but then South America had logistical issues getting the beans out of the fields, causing an unexpected rally. I expect some traders will remember this and will hold on, waiting to see harvest progress in the next 45 to 60 days.
The benefits of selling options explained
I hear analysts frequently talk about how selling options is risky. They’ll often say things that scare farmers out of considering alternative solutions with misleading and sometimes outlandish claims that provide little detail, education or explanation. What many farmers don’t understand is that these analysts are often looking at these trades as a speculator. And as a speculator, yes, selling options could be risky and may not be advisable.
Farmers have very different goals and objectives than speculators though, and often some analysts don’t take that into consideration. The key difference, and to me it’s a big one, farmers ALWAYS have more grain to sell. Speculators don’t. This key difference makes advice from analysts/speculators to farmers somewhat misguided. That’s why I advise farmers to think about what their goal is and look for trades that help achieve those goals.
During this sideways market the past year, I’ve had some success with selling corn options that have allowed me to pick up some additional premium as prices stay at unprofitable levels. One of my strategies on some of my production has been to sell straddles. This involves selling both a put and a call at the same price and at the same time. Following provides trade detail and rationale for a previous trade that just expired. It also shows why considering selling options may be a reasonable choice for farmers.
Options – Straddle – Corn
Back on 10/24/17, when March corn was $3.60, I made the following trade on 10% of my ’17 production.
- Sold — January $3.60 straddle, where I sold both the $3.60 put and $3.60 call and collected a 15-cent premium
- Trade Expiration — 12/22/17
- Potential benefit: If March futures close at $3.60 on 12/22/17, I keep all of the 15-cent premium.
- Potential concern: Reduced or no premium if the market moves significantly in either direction.
- On every trade, I know, and am willing to accept every possible outcome: every penny lower than $3.60 I get less premium until $3.45, at $3.45 or lower and I will be losing money on this trade penny for penny and for every penny higher than $3.60 I get less premium until $3.75. At $3.75 or higher I have to make a corn sale at $3.60 against March futures, but I still get to keep the 15 cents so it’s like selling $3.75.
When doing straddles I am most profitable if the market is at the strike price at expiration. The further from the strike price, essentially the more money I lose on this trade. That kind of trade may sound very scary to a speculator. But, I’m not a speculator, I’m a farmer with very different goals.
Obviously this trade is most profitable if the market stays sideways, because I’ll pocket the money and add it to a previous trade I have made. Considering how the market has been trending this past year, this seems like a likely outcome.
If the market rallies, you’ll miss out
I don’t think I will “miss out”, because if the market rallies, I think that would be great. This particular trade only represents 10% of my ’17 production. If the market goes to $4 (for instance), yes I’ll have to sell this 10% for $3.75 but then I could start to sell any remaining ’17 production I have unpriced and maybe even some of my ’18 production. I didn’t think this was likely given current market conditions, but I was and I’m still hoping like everyone else that it will happen.
This is an example of a difference between speculators and farmers. Farmers always have more to sell, so we are ALWAYS hoping for a rally, no matter what. That’s not always the case for speculators
What if the market goes down?
The biggest risk in this trade was if corn fell below $3.45 at the end of December. The reason is because I would have either had to take a loss on the trade or it could mean re-ownership of grain, which is usually the last thing I need as a grain producer. Generally I never do straddles unless I already have previously sold grain. This is what limits my downside risk. If the prices fall I can let the straddle trade get exercised and remove a previous sale and take any profits on the difference between what I sold on a previous futures sale and where the straddle makes me re-own grain. This is something I always have to be prepared for even if I think it’s unlikely.
Corn traded to about $3.5225 on 12/22/17 and I was able to buy back just the put portion of this trade for 7.75 cents and I let the call portion of the trade expire worthless. In other words, I made 7 cents net profit on this trade.
While that doesn’t seem like tons of money, it goes into my “pot of premium” that I’ve been collecting each month on trades like these. Eventually, I’ll sell the remainder of my ’17 production and I can include these additional premiums to my bottom line.
New Trade – Options – Straddle – Corn
After the success of the trade above and expecting the sideways market to continue, on 12/27/17 when May corn was $3.62, I did another straddle on 10% of my ’17 production.
- Sold — April $3.55 straddle, where I sold both the $3.55 put and $3.55 call and collect an 18-cent premium
- Trade Expiration: 3/23/18
- Potential benefit: If May futures close at $3.55 on 3/23/18, I keep all of the 18-cent premium.
- Potential concern: Reduced or no premium if the market moves significantly in either direction.
- On every trade, I know, and am willing to accept every possible outcome: every penny lower than $3.55 I get less premium until $3.37; at $3.37 or lower and I will be losing money on this trade penny for penny; for every penny higher than $3.55 I get less premium until $3.73; at $3.73 or higher I have to make a corn sale at $3.55 against March futures, but I still get to keep the 18 cents so it’s like selling $3.73.
Similar to the trade above, I’m most profitable on this trade if the market stays sideways through March. If this happens, I’ll take the additional premium and add to my “pot of premium.” If the market rallies, I’ll have to sell some of my unpriced grain at higher levels than we are today.
The biggest risk is if corn falls below $3.37 on 3/23/18. While not ideal, I can buy the straddle back for a loss or remove a previous sale and take profits on the difference between what I sold previously and $3.37 against the May futures. I would likely only remove a previous sale if I felt there was a likely chance of a future market rally. However, that decision would have to be made at a later date when I have more market information.
As always the market can go three different directions, up, down and sideways. I understand all possible outcomes of those three scenarios on each trade I make. Up is always great. Even if the trade isn’t most profitable with a rally, I always have more corn to sell, so while I take that into consideration, it really doesn’t matter because I’m happy either way.
Selling options and straddles, like the examples above, can be profitable in a sideways market. By including these types of trades in my grain marketing strategy, not only am I profitable during rallies, but I can build premium during sideways markets too. This means that I can be successful in two different market scenarios — rallies and sideways markets, or 2 out of 3 possible outcomes.
Market drops are inevitable and need to be considered too. After all, they happen 1 out of 3 times. Generally I try to limit my downside risk by understanding the potential loss of each trade. By putting protections in place and maintaining flexibility when considering all trade opportunities available to me I’m able to reduce some risk.
Opening up a marketing strategy to include selling options doesn’t have to be scary. It actually can provide more flexibility and profitability if done correctly. When taking advice it’s always important to make sure goals align before making any decisions. I always ask myself what will happen if the market moves 50 cents or even $1 per bushel in EITHER direction. After all, the bottom line is to make sure my farm operation remains profitable 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.
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