Options Strategies for trading soybeans, record yield or not

July 24, 2017 01:58 PM
Despite a recent dive in prices, fundamentals should keep beans struggling for some time.

Buy low and sell high: It’s the cornerstone philosophy of trading and investing that has been pounded into us since we all looked at our first price chart. New converts to commodities, however, learn that selling high and buying back lower can be just as easy – and just as, if not more, effective in these versatile markets.

However, options offer strategies where traders can be less precise in their bets and still earn profits. Option selling does not require a trader to necessarily buy low and sell high or vice versa. We stopped caring about buying low and selling high. We don’t really care if a market is at a high or a low.

Thus, while many of the articles you read discuss markets in which there is a “bullish” or “bearish” fundamental outlook – whether the price of that commodity moves up or down is technically irrelevant. If you are selling a call because you believe the market is going down, you’re missing the point.

It doesn’t have to go down to make money for a call seller. It just has to not go way, way up. There is a big difference there. The reverse is true for the put seller. You don’t need a bull market to make money as a put seller, you just need there not to be a crash. 

For put selling, you seek out markets that are least likely to crash; for call sellers, you seek out markets least likely to experience a sharp rally. 

Which brings us to the soybean market. The novice may look at a soybean chart and think “this market has just taken a nose dive (see “Beans take a hit,” right). Why would I want to sell it now?” An experienced option seller may look at it and think, “This market has sold off for some very strong fundamental reasons and is unlikely to recover anytime soon. It could be a stellar market for collecting call premium.”

Soybean prices have sold off sharply this spring. As with most significant price moves, there are some powerful fundamentals behind this downtrend. Whether prices continue to trend lower remains to be seen. However, for markets like this to rally, it typically needs some good reasons. At this time, the soybean market has few. Thus, despite the recent selloff, it becomes an ideal candidate for call selling. 

Why Did Prices Fall?

Soybean prices declined this spring largely as a result of a second mammoth year of South American production. Because of this, 2016-17 global soybean ending stocks will hit a record of 90.14 million metric tons, while 2017-18 stocks are expected to be the second highest on record. The onset of Brazilian and Argentine harvests in March served as a catalyst for selling, and bean prices responded in turn. World Soybean Ending Stocks will hit a record for the 2016-17 crop year and are expected to remain burdensome in 2017-18.

The global supply glut was enough to usurp what is generally a supportive time for U.S. soybean prices. U.S. planting season has historically brought at least some form of weather premium into the market – firming prices at least until the crop is in the ground.

Once planting is completed, it is not uncommon to see anxiety exit the market, and prices have often responded accordingly as the seasonal averages show (see “Soybean seasonals,” below). U.S. Planting Moves Ahead

This year, however, has seen quite the opposite. Why? On top of the global supply glut, U.S. farmers are planting a record 89.5 million acres of soybeans this year (see “Record planting on pace,” below). 

There has been little concern regarding planting weather thus far in U.S. growing regions. As of the latest U.S. Department of Agriculture (USDA) crop progress report (May 10), U.S. soybeans are 32% planted, right where they should be for this time of year based on a 20-year average. 

The result of this increased acreage? Assuming an average yield of 48 bushel per acre, 2017/18 U.S. soybean production would hit 4.255 billion bushel – with ending stocks hitting 480 million bushel – the highest in over a decade. Stocks to usage at 11.3% would also be the highest since 2006 (see “That’s a lot of beans,” below). 

With U.S. production contributing to overall global supply woes, the price picture does not look fundamentally bullish for soybeans. Sporadic rallies can happen in any market and it would not be surprising to see a rally off of weather news as the U.S. summer progresses. However, the burdensome global supply picture should keep a lid on any rallies and prevent them from getting out of hand. 

The risk of a breakout move is much more likely on the downside. The USDA is assuming an average yield of 48 bushel per acre. However, 2016’s crop yielded a whopping 52 bushel per acre. While USDA credits ideal weather for the robust yield, genetic engineering, and more efficient fertilization techniques played a roll and will make 50+ bushel yields the norm in the coming years. 

Should 2017 yields hit last year’s levels, U.S. ending stocks could soar well above 500 million bushels – further exacerbating the oversupply issues.

With global ending stocks at record levels, 2017 U.S. planted acreage at record levels, a healthy start to U.S. planting and a strong seasonal tendency to the downside in coming months, soybean prices will have a hard time staging any kind of sustained rally in the months ahead. 

Despite the recent selloff in bean prices, we feel that call sales will continue to be a high yielding cash cow for investors this month. We will continue to position managed accounts in this market as the situation dictates. For individual traders, we suggest considering selling the November 11.60 calls for premiums of $500 or better. In “Beans take a hit,” you can see any rally would need to take out several resistance levels before breaching this level. 

The market reached oversold territory in April and rallies are possible this summer. Such rallies can be treated as opportunities for selling additional calls at strikes of 12.00 or above. 

If the 2017 crop comes in at even average USDA yield projections, prices could fall well below $9.00 by harvest. But perhaps more importantly, for traders considering selling call instead of simply shorting beans, a marginally weaker yield won’t be able to overcome record stocks and produce beans anywhere near the teens.  

About the Author

James Cordier is the founder of www.OptionsSellers.com, an investment firm specializing in writing commodities options for high net-worth investors. He is the author of The Complete Guide to Option Selling 3rd Edition (McGraw-Hill 2014).