Grain Spreads: Take the Collection in KC Wheat

Sean LuskGeneral Commentary

For weeks I have been advocating taking a different approach when considering catching potential protracted moves in the market. It calls for selling either 50 cent to a $1.00 wide deep in the money put spreads. This strategy allows one to stay static long in the market, put up reduced margin in most cases, and most of all is a reduction of risk. The immediate benefit is that you get paid upfront, and you can use the collection to position in other markets. One trade I am considering long term calls for the selling of the July KC wheat 6.00/5.00 put spread. I look to sell this spread at 88 cents. Considering the spread itself is a $1.00 wide, that a 1.00 or 12 cents in this case would be the maximum loss plus commissions and fees. Am I saying that I think July KC wheat is going to 6.00? Not exactly. 5.98 was last years high on the weekly continuous chart and in years past we have seen rallies that pushed KC wheat into the 7.00, 8.00, and 9.00 handles going back the past ten years. We have also seen this market trade below 4.00 a few times in three of the last four years. What I am saying is that it in my opinion you will have an opportunity to buy back this spread cheaper than 88 cents at some point in the future. That is my opinion. However if it never rallies and prices move down to 20 year lows and I am completely wrong, I will initiate a 10 cent stop loss upon entry. Risking $500 per spread plus commissions and fees. Initial margin at selling the July KC 6.00/5.00 put spread at 88 cents, where the max loss is 12 cents plus commissions and fees comes in at $403 per spread. Maintenance/Hedge margin is $366.00 per 1 lot spread. This would be a stand alone margin at 88 cents, and if the spread moved against you, the requirement would most likely increase.

There are pitfalls with any strategy and this one is no exception. For me it is the closer the July 20 options approach expiration, the greater risk in having the short puts exercised prior to option expiration. In this case the short 6.00 puts could be exercised into long futures. However if one is long the 5.00 put against this new futures position, the protection would still be there. Therefore we might consider an aggressive counter here.

Sell the July KC wheat 6.00/5.00 put spread. Collect 88 cents ($4400.00) minus commissions and fees. Double up the long side by using that massive credit to simply buy the July 2020 call spread 5.00/5.50 for 8 cents. Now the collection is down to 80 cents minus commissions and fees. I would stick offers on the 5.00/5.50 call spread at 30 cents and bid to buy back the short 6.00/5.00 put spread at 40 cents. Closing both sides in this example would net a ten cent debit. The end result would be a gain of 70 cents minus commissions and fees in this example. This is only one strategy and hedgers/producers can use this to their advantage in my view. For example: A hedger can sell the July 6.00/5.00 put spread at 88 cents. Where the max loss is 12 cents as a spread plus commissions and fees. Use that 88 cents to buy Sep or Dec 450 puts for 25 cents OB. Giving you a floor at 4.50 through harvest. Again just one thought here. There are plenty of ways to go. Critics of this strategy have asked , Why don’t I just bypass these option strategies and just buy futures? I quickly tell them that there are no sure things in trading commodities and that the risk is far greater in outright futures where the margin requirement is 4 times higher than the options spread. In my view in the current environment, one tweet, facebook post, over the weekend off the cuff comment from anyone can send prices spiraling lower/higher. Its becoming the norm rather than the exception and the market is hyper sensitive to them in my opinion. Therefore if one wants to reduce the risk, margin, and at the same time take in a sizable collection, then please reach out and lets talk. Selling five of these spreads at 88 cents would collect 22 K. With a ten cent stop loss, the risk is 2500.00 plus commissions and fees. One can sit with that collection and look to buy back with the goal of giving as little as possible back. I previously have discussed the same strategies for corn and beans in previous posts and on my weekly
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