Feeling Cautiously Bullish on 2020 Beans?

Timothy BraceGeneral Commentary, Grains

With a cautious but bullish sentiment for next year’s soybean crop, irrespective of fees, a “zero-cost,” hedging strategy is achievable which allows for 25 cents of upside profit potential from the current futures price , with protection on the downside just 15 cents lower. This strategy is possible due to the implied volatility skew to the upside common in grain options. A “skew” in prices means that options that are equally out-of-the-money relevant to the current underlying futures prices, trade at significantly different prices due to a general direction bias or fear of a strong move in a particular direction, which in grains is most often to the upside.

Specifically, with Nov. 2020 bean futures currently trading at 975, both the Nov. 2020 1000 Call and the Nov. 2020 960 Put are trading for 45 cents, making it possible to execute a spread known as a risk reversal, where you could sell the call and buy the put on a one-to-one basis, for even money, irrespective of fees. This trade, colloquially known as a min/max spread, which could be implemented for hedging perhaps 20% of new crop production, would result in your selling Nov. 2020 soybeans at a maximum of $10.00 per 5,000 bu. contract at any price above 1000 at option expiration, allowing for full upside profit potential to the $10.00 point, or at a minimum of $9.60 for each 5,000 bu. contract at any price below 960 at expiration.  The “beauty” of this spread, is of course that, other than the associated trading fees and any potential margin requirement, it is possible to execute this trade for “zero-cost.”

By Tim Brace, Senior Broker
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Note:  Selling (“writing” or “granting”) an option or option spread, generally entails considerably greater risk than purchasing options. Although the premium received by the seller is fixed, the seller may sustain a loss well in excess of that amount.”

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