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Profitability on straddle trades

Sometimes ideas for trades come from unlikely circumstances. While I was presenting a grain marketing seminar in February a farmer said he would never consider selling options because of the risk of large price movements. While I understand his fear, I don’t agree. Farmers’ fear of selling options can be due to many factors, including lack of education, complexities of the trades, and misunderstood risk exposure.

I asked this farmer where he thought July corn would be on 6/22/18. He first said he had no idea, and I agreed, as I don’t know either. However, I asked him to take a guess. He said since corn was around $3.80 on that day, that it would be a reasonable estimate that corn would be around $3.90 in late June. I agreed, that would be my guess as well, based upon what we knew that day. I actually came up with the following trade on the spot to illustrate my point with the farmer in the presentation. However, after spending more time thinking about it, I thought it had potential in my marketing strategy as well. Following are the details of the trade:

 

On 2/26/18 when July corn was $3.82

  • Sell a $3.90 straddle (where I sell both the put and call for the same strike price)
  • Buy a $3.60 put
  • Collect a total of 28 cents premium for the trade

I then walked the farmer through all the possible outcomes of this trade.

  • If corn is below $3.62 on 6/22/18, I don’t get to sell any corn and I could lose up to 2 cents MAX (Note: the $3.60 put purchase minimizes the downside risk in this trade)
  • If corn is above $4.18 on 6/22/18, I have to sell 10% of my 2017 production for $3.90 plus the 28 cents from the sale of the options, so I would get $4.18 total.
  • If corn is between $3.62 and $4.18, I will make some premium on this trade but no sale has to be made. The closer July corn is to $3.90, the more of the 28 cents premium I get to keep.

Worst case scenario — prices fall below $3.62 and I lose 2 cents. I didn’t, and still don’t, think this is likely right now, but I’m comfortable with this scenario if it happens.

Better scenario – corn prices are above $4.18. While I will have a price ceiling of $4.18 with this trade with a few of my bushels, I’ll be happy to get that price. Plus, if prices go this high or higher, I have more corn to sell and can still take advantage of that opportunity.

Best case scenario — corn prices fall between $3.62-$4.18 and I pick up some premium. Like the farmer I met, I think it is most likely that corn prices will be around $3.90 in late June. If that happens I could pick up nearly 28 cents of premium on some of my bushels.

I’m comfortable with all possible scenarios, so I placed the trade.

 

Market action results – April option expired

As always, I like to report back on how the trades I write about turn out. I like to be fully transparent, including the good and the bad, because there is always something to be learned in providing details of actual trades, rather than theoretical ideas or general market statements.

Sold a call — Results

On 12/27/17 when May corn was $3.62. I sold an April $3.60 call for 10 cents against 10% production of my ’17 production.

What does this mean?

  • If corn is trading below the strike price when this option expires I keep the premium and add it to another trade down the road.
  • If corn is trading above the strike price when this option expires I have to sell corn for the strike price PLUS the premium.

I don’t really want to sell corn for $3.60 against May futures, but if it happens, I would actually get $3.70 with the 10-cent premium. Not ideal, but not terrible considering the price level trending at the time. Plus, I’ve made some premium selling other calls that I could apply to this trade to increase this sell price.

 

What happened?

Corn was above $3.70 on 3/23/18, so I sold 10% of my production at $3.70. Again, this is not an ideal trade, but I have enough premium captured from other trades up to this point that I’ll be able to pull this sale up to profitable levels. Since I never know for sure where the markets are going this is bound to happen from time to time. This is another reason why capturing added premium in the market whenever I can is so important for my marketing strategy.

 

Straddle trade — results

On 12/26/17 when May corn was $3.62, I sold a 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 Expires on 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. For every penny lower than $3.55 I get less premium until $3.37. At $3.37 or lower 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.

I am most profitable on this trade if the market stays sideways at the end of March. If this happens, I would take the additional premium and add it to my “pot of premium” I’ve been collecting by selling options during the long-term sideways market. If the market rallies, I would have to sell some grain at higher levels than where prices were in December.

If corn falls below $3.37 on 3/23/18, it isn’t as ideal. I would either buy back the straddle for a loss or remove a previous sale and take profits on the difference.

What happened?

This is a great example for why I always write down why I make trades. Time passes, and it’s not always easy to remember your mindset when placing trades without notes. In December most corn predictions were doom and gloom. Many thought the sideways market would continue until at least summer or possibly longer. I was trying to add premium, instead of waiting and hoping for rallies that might not come. Ultimately, the market outperformed where I thought it could go, which is a great thing for all of my ’17, ’18 and ’19 corn I still need to price.

On 3/20/18, when May corn pulled back to $3.74, I bought back the $3.55 call portion of the straddle for 19 cents. I left the $3.55 sold puts to expire on 3/23/18. With the 18-cent premium from the original sale of straddle, I’m only down 1 cent before commissions. Since I let the sold $3.60 call trade above execute, and I’m bullish corn right now, I didn’t want another sale at the $3.70’s level to happen this month.

Basically, this trade was almost a wash in the end (down 1 cent), but it had the potential for added premium if the market stayed sideways, which seemed very likely at the time and why the trade was originally placed. I’m fine with the outcome of this trade. Straddles have been making me quite a bit of premium up to this point.

 

New straddle trade

With one straddle coming off this week but not resulting in any additional sale I want to replace it with another one. This also allows me to offset the 1 cent loss of the previous straddle trade. Details are as follows:

  • Sold – Sep $3.80 straddle (sold both the $3.80 put and $3.80 call)
  • Bought – Sep $3.60 put
  • Collected – 34 cent of premium
  • Trade Expiration – 8/24/18
  • Potential Benefit – If Sep futures close at $3.80 on 8/24/18, I keep all of the 34 cent premium, less the 1 cent loss from above straddle trade. After all commissions from that straddle trade above and this new straddle, I can make potentially another 30 cents of 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. For every penny lower than $3.80 I get a penny less of my premium until $3.60. At $3.60 or lower I don’t sell anything, but I’m guaranteed at least 10 cents of premium, that I can apply to my pot of premium I have been collecting this year for the ’17 crop. For every penny higher than $3.80 I get a penny less of my premium until $4.10. At $4.10 or higher I have to make a corn sale at $3.80 against Sep futures, but I still get to keep the 30 cents so it’s like selling $4.10. Between $3.60 and $4, I’ll make a premium of 10 to 30 cents, but no additional sale has to be made.

With the loss on the April straddle and replacing it with this Sep straddle I’m “kicking the can down the road.” I don’t want to sell corn near $3.70 against May futures. I want more upside potential because I believe the markets are in a different place than they were three months ago.

This trade is most advantageous if the market remains steady or higher. Even if the market drops, I’m guaranteed to not lose any money from the options. The only negative with this trade is if the market drops in late August and I don’t take an opportunity beforehand to get more of my ’17 corn priced above a level equal to $3.73 against the May.

 

New 2019 corn sale

On 3/13/18 when corn rallied, an order I had in place was hit and I sold my first 10% of production for 2019 at $4.18 against Dec ’19 futures.

 

Am I missing out on rallies?

Several farmers have wondered if all my straddle and sold call positions keep me from taking advantage of market rallies, like the most recent one I witnessed.

As I always say, I’m fine missing out on a rally with some of my bushels because I always have more corn to sell. With the most recent unexpected rally, old crop corn futures rallied 30 cents over the last 90 days. With all of the options positions I had in place, I still collected about 15 cents of premium, or about half of the recent rally that most people, including me, didn’t expect would even happen.

By including trades and options that are basically a bet against what I really want to happen in the market allows me to have a more balanced and controlled marketing plan. Waiting and hoping for a rally relies too heavily on luck and timing, which are impossible to predict long-term because there are too many variables.

I prefer a marketing plan that has potential profit when the market trades sideways at unprofitable prices for any amount of time. I can still be ready to take advantage of rallies with future unpriced corn if opportunities become available. This strategy seems much safer and less risky to me than waiting for uncertain rallies to come. The sideways market of the past year is a great example that rallies are unpredictable and may take a long time to develop. My marketing strategy isn’t to hit the top of every rally, which is impossible to do, but keep my farm operation profitable year after year.

*** It should be noted that I choose to reown the straddle trade instead of the call trade. I could have chosen either trade to buy back and replace with the Sep straddle. The end result of my trade values should be equal with either trade because the straddle would have earned me a $3.73 sale instead of the call that only earned me a $3.70 sale. The losses would have been 3 cents more on the buyback of the call but the futures sale with the options premium collected would have offset this loss ***

 

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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