Is fading corn rally a good play?

The run up in corn prices in late April early May has brought out the grain bulls in the agricultural futures arena.

As we discuss in our latest Futures Magazine article, Springtime and the crop perils that come with it, can often mean higher prices for fearful industry participants and profit seeking speculators. Yet these planting related fears can often be unfounded and this could currently be the case in the Corn market. While we still feel bulls may consider selling puts underneath the soybean market due to longer term stock builds, corn is facing a different set of fundamentals.

The monthly USDA supply/demand report released May 12 showed U.S. corn ending stocks for 2008/09 at 1.6 billion bushels. This is below last months 1.7 billion bushel estimate and below most analyst expectations. Projected stocks to usage ratio for 2008/09 is pegged at 13.2%, slightly above the 2007/08 estimate.

While the report was deemed “mildly” supportive by most traders, the market pushed higher earlier this week on the strength of the report and “weather concerns” in the Midwest. Too much rain is hindering farmer’s planting efforts to get the 2009/10 crop planted. This is what is really bringing out the buyers. Anxiety over crop planting is almost as reliable as sun and rain itself.

Yes, everyone is getting bulled up. But before you sell the house and buy it all, you may want to consider a few key facts.

A carryout of 1.6 billion bushels and a 13.2% stocks to usage ratio is somewhat average by historical standards. (See above chart) There is no shortage of corn as we speak.

Concern is coming primarily for the 2009/10 crop. Since this crop is not even fully in the ground yet, estimates on next year’s total supply minus all usage is based on much speculation. While analysts take a stab at 2009/10 ending stocks (see above chart), there are simply too many variables between now and Sept 2010 to make reliable estimates.

I have rarely seen the problem of “too much rain” turn into a longer term problem for the crop. In fact, farmers almost always find a way to work around wet conditions to get the crop planted. Too much rain in May often leads to ideal growing conditions in June and July as the soil holds adequate moisture reserves for dry spells during summer months.

My gut feel here is to fade additional strength in corn prices over the coming 10-14 days. We recommend selling deep out of the money calls far above the market which will give traders plenty of room to ride out additional price strength should the market continue to focus on rain.

Otherwise, adequate on hand supplies should allow the trade to begin to pressure prices again once the crop gets planted and the market begins to focus on all of that moist soil.

Coincidentally, there is no conflict being short soybean puts and short corn calls. Both can be successful trades at the same time. Soybeans do not have to move higher and corn does not have to move lower. They simply need to stay above and below their respective strike prices.

The weather related volatility has pushed premiums up for distant strikes on both sides of the market. Indeed, May weather has it’s advantages.

Liberty Trading Group,401 East Jackson Street. Suite 2340,Tampa, FL 33602, 800-346-1949www.OptionSellers.com

For more information on option selling on the commodities markets or option writing portfolios with Liberty Trading Group, feel free to call us at 800-346-1949 or visit us at www.OptionSellers.com and request your Free Option Sellers Information Pack. James Cordier is the founder of Liberty Trading Group/OptionSellers.com, an investment firm specializing in exclusively in selling options. Michael Gross is an analyst with Liberty Trading Group/OptionSellers.com. Mr. Cordier’s and Mr. Gross’ book, The Complete Guide to Option Selling (McGraw-Hill 2005) is available at bookstores and online retailers now.

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