By Jon Scheve, Superior Feed Ingredients, LLC
Due to COVID-19, two recent straddle trades didn’t go as planned. While it’s always disappointing when this happens, it’s important to review what happened, what can be learned from the situation, and how to move forward in a positive way.
My history with selling straddles
Since 2016, selling straddles has represented about 30% of my grain marketing strategy. I use them to try and capture profit from a sideways market. The trade involves selling both a put and a call at the same strike price.
Selling straddles can force sales at higher values, which makes for a strong strategy. As a producer I’m happy with rallies because, I always have more grain to sell at higher prices. Selling straddles helps me maximize profit potential when the market stays sideways, which has happened a lot in the last 3 years.
The downside of selling straddles
Straddles don’t have a built-in floor price, which opens me up to unlimited downside risk. I can minimize that risk by purchasing out of the money puts, but those added costs cut into my profits. With a consistent sideways market, this has previously seemed an unnecessary expense for the first 6 months after harvest is complete.
In February I sold my 50th straddle in the last 3 years. Of those 50 straddles:
- Nearly 70% had provided me some type of profit on the trade.
- About 20% turned into a forced sales position to the upside. Half of those were in 2019 alone.
- Only 10% lost money and those losses amounted to only 2, 10, 10, 15 and 25 cents each or 62 cents total over the 3 years.
How often do you purchase protections in case the market drops?
Only about 20% of the time have I bought put protections to protect myself from loss on the straddles. I usually have done this when the straddles are expiring in the last half of the year when the corn market is in a seasonal downward trend. It usually costs between 2 to 8 cents, with the average costs around 4 cents, to have a floor protection on my straddles. This means on the 40 trades where I didn’t buy put floor protection, I’ve saved at least 160 cents over the last 3 years.
Two recent straddle trade results
On Feb. 19, May corn was trading $3.85. I sold an April $3.90 straddle collecting 14 cents and a $3.90 May straddle collecting 20 cents.
From Nov. 1 of last year until I had placed the trades above on Feb. 19 May corn had traded between $3.76 and $4.00. At the time it seemed carryout could get tighter because there was less corn in the U.S. than the market believed only a few months prior. Therefore, it seemed reasonable that corn would trade sideways or a bit higher as we moved further into spring. At that time, it seemed unlikely the market would trade much lower given the recent range.
With the straddle trades now in place I could make a profit on each trade if the market was between $3.76 and $4.04 when the April straddle expired at the end of March, and between $3.70 and $4.10 at the end of April when the May straddle expired. The previous 3 months indicated that we would likely stay in that range. If the market was above these ranges, I had to sell at the top of each range, which I was fine with doing. While the downside potential was possible, we would still have the weather markets of the summer ahead of us. This seemed to indicate a long-term sideways pattern was probably present, and that these trades seemed like a good decision.
Covid-19 hit, and it was worse and lasted longer than many could have imagined. Shelter in place programs killed gasoline and ethanol demand. I was forced to buy back the put portion of the April trade for a 32-cent net trade loss and the May trade for a 50-cent net loss. Luckily these trades only represented 10% each of my 2019 production.
Should I have bought purchase protections?
Hindsight is 20/20, so yes, I wish I would have for these two trades. However, it’s important to keep things in perspective. If I total up all of my losses, now on 7 of 53 total straddles in the last 3 years, I’ve lost 144 cents. Since it would have cost me about 160 cents to buy floor protections on the 43 straddles, I never bought put protection on, I’m actually ahead over the long run.
When the April straddle was about to expire, and July corn was still trading $3.55, I replaced it with a July $3.50 straddle and purchased a $3.20 put while collecting 32 cents of profit. This gave me full downside protection on the trade. This would have forced me into a sale at $3.82 if the market was higher at expiration. Unfortunately, corn went lower and this trade expired on Friday with July at $3.18. This means that I walked away with 2 cents profit on the trade, which covered all of the commissions. Actually, had I not bought the put protection on this trade, which cost me nearly 6 cents I would have made 6 cents more profit on the trade. But with the uncertainty of the markets during these times I felt it prudent to cover all downside risk.
I replaced the May straddle with a September $3.20 straddle on April 22 when September corn was trading at $3.30. After purchasing a $2.90 put protection floor, I collected 36 cents profit. The straddle forces a sale at $3.56, but with what I know today that may be difficult. Regardless, I have a guaranteed 6-cent profit on this trade no matter how low corn goes at the end of August.
While I’m disappointed with any loss, these two were mostly due to an unprecedented pandemic that most didn’t see coming. Of 53 total straddles I have now traded in the last 3 years, 67% of the time I’ve turned a profit. 20% of the time I’ve had a forced sale that I’ve been happy with making. That means selling straddles has had an 87% success record as part of my grain marketing plan.
Just because a couple trades didn’t go my way, I’m not going to abandon a trade strategy that’s helped me be profitable during sideways markets in the past so consistently. After all, with prices so low right now, I need to use every tool in my grain marketing tool box to maximize profit potential. Sideways market will likely happen again.
Please email firstname.lastname@example.org with any questions or to learn more. 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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