From the June 01, 2011 issue of Futures Magazine • Subscribe!

Exploiting wheat’s weak sister status

Market Strategy

These supply figures indicate that the wheat market will enjoy a more stable supply cushion to begin the 2011/12 harvest season than will corn or soybeans. But those supplies are, as they say, "in the barn." The market will now turn its focus to growing season 2011.

While weather concerns can pop up anywhere, the severity of 2010’s problems is rare. More "normal" weather patterns are expected for much of the major wheat producing regions. Countries such as Russia are expected to lift export bans imposed last year as a result of domestic production shortfalls. India will begin exporting wheat for the first time in four years, and is expected to harvest a record 84.3 million tons this year. Most importantly, however, is that wheat enjoys a much larger margin for error than does corn or soybeans due to its healthy ending stocks. This should make its price less susceptible to sudden surges than that of corn or soybeans. True, wheat probably will lose the acreage battle to corn and soybeans in the United States this year, and most likely will perform as a weak sister in the grain and oilseed complex in 2011. This means it will lag corn and beans in a bull market and lead the way in a bearish reversal.

For these reasons, we see wheat as an excellent hedge for traders already short corn and soybean puts. Option writers look to sell deep out-of-the money puts in bull markets and deep out-of-the money calls in bear markets. However, bull players who sell puts often will sell calls as well to take advantage of overpriced strikes far above the market even if they think prices will continue higher. This is especially true this time of year when grain prices often correct once planting is complete. Instead of selling bean or corn calls, stay short the puts in these markets and sell your calls in wheat.

If bull market conditions continue, wheat calls likely will appreciate more slowly than those of corn or soybeans. In a corrective environment, their profit likely will offset any temporary pressure on soybean or corn puts. The object, of course, is to have all of them eventually expire worthless.

James Cordier is the founder of investment firm Liberty Trading Group/OptionSellers.com. Michael Gross is an analyst with Liberty Trading Group. They wrote "The Complete Guide to Option Selling," 2nd Edition (McGraw-Hill 2009). Visit them at www.OptionSellers.com

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