From the September 01, 2008 issue of Futures Magazine • Subscribe!

An intrinsic condor call spread

Question: You have a clear idea of the upcoming range in a market, but not the direction. What do you do? Answer: An intrinsic condor call spread

With growing demand and carryout supplies getting smaller, there is little room for a disappointing corn crop this year. Since corn became both a food and energy product about five years ago, its value has risen, providing a floor much higher than in years past. Corn has a floor price of about $4.50; anything lower will spur demand at a very rapid pace.

Weather is the most important factor in the outcome of price because when you have more than 87 million acres planted, a one bushel difference in yield produces 87 million bushels more or less corn supply in the bin.

Here it is Sept. 1 and the market has no idea of how many acres really were planted, were abandoned, and what the yields will be. It all depends on the weather. The market will have more of an idea by mid October, and until then it is really a crap shoot. The final factor will be the chance of an early frost, which would cause yield and quality problems. Just the forecast of such an event will cause the market to rally. In the corn belt the average first frost is Oct. 7, but this year with the late planted crops due to excess rainfall, it needs to be a week later.

With a probable floor at $4.50, and if there is not an early frost, prices will be no higher than $6.80 from now until the end of 2008. You can use those prices as a reliable range. Yield estimates from the major research firms, with all the variables this year has presented, have been wildly diverse and it never pays to bet on a weather variable, so how can you profit with these wide ranging expectations? By using a long December corn condor call spread. Basically it buys an intrinsic vertical spread and sells a vertical spread that is out of the money at the same time. This strategy has a known risk and reward potential and gives you the time to be right or exit whenever your thoughts change. You also can morph into another strategy based upon new fundamentals. Here is what you can do:

Buy a December corn $4.80 call, sell a $5.80 call, sell a $6 call and buy a $7 call, for a total premium of 41¢ (see “Condor table”). Your risk is $2,050 plus commissions if you hold until expiration and the market is below $4.80 or above $7. If the market is at $5.21 or $6.59, you will get your 41¢ back and just lose the commission paid. Any price in between those numbers will be a profit, with the most profit coming if the market is between $5.80 and $6, which would make this worth 59¢ - commissions ($1 profit - 41¢ in premium or $2,950 - commissions). The risk reward is $3 gained for every $2 wagered (3 to 2). Remember, this is a strategy that could make money whether the market is 75¢ higher or 60¢ lower, but is worth the gain of 59¢ if the market is 15¢ to 35¢ higher than when you put this on.

Futures positions will only make you money if the market moves in your direction. The problem with futures is that you must manage the time needed to be right without getting stopped out first. It is no good being right the market next month if you are forced out now, and if you do not have a way to control losses, futures can move to the point of leaving you no choice but to exit your position. Maybe you thought futures were going up 50¢ and you bought with that objective, but corn just broke over $2 from its high in three weeks. It is never wise to risk more in a trade than your profit target. Those are the reasons to consider this strategy.

This strategy allows clear thinking under extreme conditions. This strategy cost approximately 41¢ based on the $5.85 close of December corn on Aug. 1. If that was expiration, it would have been worth 85¢. With no clear thought of direction, this is a smart strategy allowing the potential for 59¢ profit.

Howard Tyllas is registered with the CFTC as a floor broker and CTA. He’s a member of NFA and a veteran trader of 31 years. He has traded options on futures since their inception. www.howardtyllas.com .

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