Trade report on put options
In early May, we advised selling put options in corn based on the outlook for investor jitters over a delayed spring planting. We outlined the solid fundamentals supporting corn prices and speculated that the delay in Spring Plantings would cause speculators to drive up the price of corn. Corn prices did react, rallying almost 33% within a month.
The crop did get planted, albeit a bit late, and it appears investors have been realizing this over the last two weeks. Corn prices have plummeted since making new all time highs over $7.50 per bushel in late June. Now the bears are coming out asking “how low can it go?” Despite what their trading systems are telling them, corn is a market that adheres primarily to old fashioned fundamentals. We had a market with bullish underlying fundamentals that experienced a scare that U.S. farmers would not get the crop planted in time. Speculators came in and drove the price up. Then the crop got planted after all. The scare went way. The bullish underlying fundamentals did not.
If you look at a corn chart, the picture becomes obvious. The market is taking the fear premium out of prices, which are gravitating to pre-scare levels. And once again, we feel these should be good value levels to begin writing puts.
In addition to on-time plantings, corn has had to deal with other bearish factors over the last few weeks. Favorable growing weather, outside influences such as falling oil prices and a general outlook for slowing global growth are pressuring corn prices. Corn’s rapid accent in June was spurred on, in part, by unrelenting rains in the U.S. Midwest growing regions. However, now that the rains have subsided, it has left corn fields in almost ideal growing conditions with sunny weather and warm wet soil.
All of this points to a healthy crop, which has led to the recent round of liquidation. A crop endangered is extremely bullish; a crop not endangered is less bullish, so the price pullback is justified. Corn prices were ahead of themselves above $7.00 and needed to come back to fair values. Meanwhile, the bigger picture fundamentals for corn remain favorable. Plantings and weather are bringing us back down to where we where before the planting scare: Corn near $6.00 per bushel in a year of tightening stocks. The latest USDA supply demand report for corn from July 11 shows a fairly sizable US crop projection of 11.715 billion bushels (bb), down 20 million bushels from last month. Combined with beginning stocks and a nominal amount of imports, total supply is pegged at 13.328 bb. Yet, projected demand for ethanol has fallen little and projected feed demand has risen since last month’s report, resulting in total demand of 12.495 bb. This leaves ending stocks at a precarious 833 million bushels for the 08/09 crop year. If realized this would be the second lowest ending stocks in over 25 years.
Ending stocks are the amount of product left over at the end of the crop year after all demand has been met and is a key figure in price discovery. The stocks-to-usage ratio is the ending stocks vs. total projected demand for the year. Pegged at 6.7%, the 2008/2009 stocks to usage ratio would be second lowest in more than 25 years. World corn stocks-to-usage ratio at 13.3% would be the lowest stocks to usage seen since the 1970s.
The bigger picture in corn then, is a market with tightening stocks. Demand for corn as both animal and human food and from the biofuel sector will continue to grow. World populations continue to expand and emerging economies continue to develop in Asia and South America. It is interesting to note that total demand is pegged to outpace total production in the United States this year (12.495 bb total demand vs. 11.715 bb total production), meaning a hefty portion of 2007 carry over stocks will be used to meet this year’s demand.
Corn prices are falling now as funds liquidate long positions built up on the weather scare in June. But corn’s fundamentals should allow it to find solid support in the $5.75 to $6.00 area as the trade will most likely be unwilling to drive prices much lower than that, given the supply situation. Look for further weakness next week as an opportunity to sell puts beneath the $5.00 strike basis December contract.
Remember, as a seller of puts, one only needs the market price to remain anywhere above his strike to eventually be profitable. Thus, prices do not necessarily need to move higher for a successful trade.
James Cordier and Michael Grosswww.OptionSellers.com
See James Cordier’s live interview on CNBC, June 9, 2008, advising investors to sell calls on the corn weather rally.
James Cordier and Michael Gross are portfolio managers with Liberty Trading Group/OptionSellers.com, one of the first futures firms in the United States to specialize exclusively in selling options. Their commodities market analysis is featured by The Wall Street Journal, Yahoo Finance, CNBC and Bloomberg Television News. They are authors of the book The Complete Guide to Option Selling (McGraw-Hill 2005). They can be reached through their website at www.OptionSellers.com where they provide free option selling tutorials. Managed option selling portfolios are available through their firm.
The information in this article has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss, and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account.
