If you’re looking to get diversified with something uncorrelated to the equities market, you can’t get much further away than the U.S. grain markets.
Grains, unlike stocks, have no earnings to watch or rate hikes to worry about. There is much less “public interest” swaying grain prices with the headlines of the daily paper.
Here, it’s old-school farmer stuff. How much is in the barn and how much are they ordering? Grains benefit from very precise and measurable supply-and-demand figures, making them amenable to fundamental analysis.
The U.S. winter wheat crop begins to sprout in January. Winter can be a stable time to trade grains. Why? Because here in the Unites States, crops are in the silo, almost nothing is growing and there are no weather concerns to worry about. Only the normal, measurable flow of supply and demand fundamentals are at play, which makes seasonal tendencies very attractive to follow in winter.
You’re not getting a trade for one market this month, but two; because trading two related commodities at once can offer you not only great yields, but an extra layer of protection. It’s how professionals get an extra edge. But you’ll rarely read about this kind of trade, especially involving option selling.
Here is a strategy we’ve termed the “Minnesota Squeeze.”
Winter: Time to grow wheat
Almost nothing is growing in the U.S. winter. Almost nothing. The U.S. winter wheat crop typically sprouts in January and grows through the spring. Wheat is actually a form of grass and you can grow it just about anywhere, even in the freeze of winter. In fact, nearly 75% of U.S. wheat production is winter wheat. Thus, although wheat can often share related price patterns with its cousins -- corn, soybeans and oats -- its seasonal tendencies can differ widely due to different harvest times.
How can you potentially make money from this? By taking advantage of the discrepancy in seasonal patterns this time of year.
Wheat prices have historically tended to decline in the winter and spring months (Season of wheat,” below). Although winter weather can indeed be harsh, there is no dry heat. Dry heat is the biggest danger to summer crops. Instead, winter wheat tends to grow predictably through its June harvest time. Thus, unlike soybean prices, which tend to begin declining after the crop is “made”, any anxiety in wheat prices tends to start receding once the crop sprouts.
Winter: Peak demand season for soybeans
Meanwhile, over in the soybean market, a different set of fundamentals is unfolding. U.S. harvest is far behind the market but spring planting is still well ahead. Brazilian soybeans will not be widely available until at least May. But demand for soymeal surges in the winter. Cattle, pork and chicken farmers in the United States, Japan, China and elsewhere are forced to move their animals out of pasture and off of grass-based food and rely on soymeal as a primary feed. In addition, animals can consume more calories in the winter as colder temperatures require them to burn more for heat.
This spike in demand is notable and has historically helped spur soybean prices from winter into spring – as illustrated in the seasonal averages (see “Seasonal soy,” below).
While wheat and soybean supplies both remain healthy at this time, it is worthy of note that seasonal price moves tend to occur regardless of outright supply or demand at any given time. Does that mean it’s guaranteed to happen this year? No, but without any foreseeable abnormalities in either market, it’s a good bet.
So, how do you monetize this discrepancy?
The Minnesota squeeze
The old farmer’s play for this seasonal is to sell the wheat futures contract and buy the soybeans futures contract, and play the spread between the two. This is a safe seasonal hedge strategy that offers many benefits. But there is a better strategy that can offer higher odds of profit than a simple inter-commodity futures spread. We call it the Minnesota Squeeze.
You can implement the Minnesota Squeeze all the way into March by selling a call far above the wheat market and selling a put far below the soybean market. This allows you to profit if soybean prices rise and if wheat prices decline.
Of course, farmers employing the simple spreads strategy would profit as well. But, by selling the options this way, you gain an extra advantage. You can profit even if soybean prices don’t rise and wheat prices don’t fall. Soybean prices don’t have to fall; they only have to stay above your strike. Wheat prices don’t have to fall; they only have to stay below your call strike. That’s an enormous advantage the farmer doesn’t have.
Also, you have one final advantage that really puts the Minnesota Squeeze over the top. Soybean and wheat prices don’t move in tandem. But they do share some related fundamentals whose alteration can affect both markets the same way. By selling options this way, you effectively create an inter-commodity strangle – and gain all the benefits that come with a short option strangle.
Most important of these is, if a factor comes along that affects both markets (think Russian Grain embargo, China trade tariff) you have one position to a great extent offsetting another.
This means a more stable trade and an additional layer of insulation against loss. If both markets move in tandem – which is unlikely but possible – at least one of your positions will be profiting, somewhat balancing the loss on the other. But the chances of a larger market moving event in the grain complex are rare in winter months, which is why you want to be in a position that is short volatility like this one.
In a grain bull market, beans should outperform wheat. In a bear market, wheat should fall faster than beans. The Minnesota Squeeze can potentially profit in both scenarios. A runaway bull market in wheat or an outright collapse in soybean prices could make a loser out of one side of the trade. Though it isn’t ironclad, it can offer particularly high odds of success if implemented properly this time of year.
It is best to initiate earlier in the winter to take advantage of premiums, but this strategy is still viable through March. We suggest legging into the position by selling the September soybean 9.00 put on pullbacks (target premium $500, margin requirement $870) and the September wheat 5.40 call on rallies (target premium $550, margin required $950). Entry points for taking this premium should be available from now through late March.
There are several states that grow both soybeans and wheat. But Minnesota had a certain ring to it. If extra protection, high yield and attractive probabilities ring for you, this is the month to take your trade to Minnesota.