Grain spreads:Long Term Gameplan

Sean Lusk General Commentary Leave a Comment

For the last few months I have been advocating selling out of the money put spreads in both corn, wheat, and beans, essentially buying next year’s or next seasons crop. In my opinion, I believe this year’s corn crop has been overstated. From the onset, the Gov’t has been overstating planted and then harvested acres. Which in my view has inflated production. I have a hard time believing harvested acres will end up being higher than 2018. Yield is the variable that’s hard to quantify right now. Some private forecasters have corn at 166 to 167 while others are at or above 169. The USDA has it at 168.4, the October estimate with recent private forecasters very similar. Yield is a tough one given the late plantings and terrible weather in the Northern growing areas, prior to much of the crop reaching maturity. Regardless of my opinion and others, I don’t think we will fully know until the January report or even the March 2020, or til the September 2020  quarterly report on what the corn crop is or isn’t. Any bullish surprises would result in higher prices in my view and put pressure on the 20/21 crop to produce. Just my opinion here. Demand though will be key after this harvest.

While corn seems too optimistic, beans have been for the most part pessimistic or seen as bullish by the trade given the numbers from the gov’t versus market expectations. Last years beans production at 4.42 billion bushels. This year’s production coming in at 3.55 billion. Will late season weather in the Northern growing areas knock this years crop down to a billion bushels under last year? Ending stocks sit at 460 million bushels per the October report. You might recall that two crop seasons ago (2017/18), final ending stocks came in at 438. The last crop year prior to the trade war/ tariffs. Drought in Argentina that year was a big reason beans traded to 1082 in the April/May 2018 time frame. Funds have taken notice in my view amassing a long position of 63 K contracts. While short covering has emerged in corn, with funds short about 60 K, down from 160 K in early September 2019.

July 2020 beans or Nov 20 beans. Have an order working to sell the July 2020 11.00 put and buy the 10.00 put for a collection at 85 cents. We settled today at 80 cents. We need a pullback to get filled at our price. Max loss is 1.00 so I wouldn’t take more than a 10 cent loss on this one depending on the fill. In my view use a stop. 10.82 then 11.00 will be prime targets should we get a weather rally. Which if it happens, would simply allow us to buy back this spread cheaper minus commissions and fees. The new crop Nov 20 beans may have more volatility in the long run especially if this year’s crop is drawn down to 350 million bushels regarding ending stocks in subsequent reports. However the Nov 20 1100/1000 put spread settled at 76 today. Work to sell at 80 with a 12 cent stop loss. Once could use that collection for a myriad of speculative trades that double up to the long side or for put protection. If you have beans to be priced for March/May, one could use these monster collections to buy as many March 920 soybeans puts (cost is 15 cents), or May 940 puts for 25 cents. You could also forego the stop loss on any of these and risk the full carry on the spreads.

Corn: The trade I really like is the Dec 2020 5.00/4.00 put spread. Sell that spread at 78 to 80 cents. It settled at 75 cents today. Use that 3800 to 4 K collection and either sit with it or buy cheap puts and calls out to May/July. If we rally, 4.68 this year’s high will be the target in my opinion. If that gets taken out, its 4.91 and then 5.16. Make no mistake though we can easily break as well. I’m not saying we cant. In my view crop losses are a certainty given the aforementioned problems this growing season. I just don’t know when they are going to show up. Which is probably why, I would bet as far out as you can in corn, Dec 20 corn options maybe the most advantageous for a long term trade.

KC wheat: Sell the July KC wheat 6.00/5.00 put spread. Collect 90 cents ($4500.00) 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 82 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 an eight cent debit. The end result would be a gain of 72 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 90 cents. Where the max loss is 10 cents as a spread plus commissions and fees. Use that 90 cents to buy Sep or Dec 450 puts for 25 cents OB. Giving you a floor at 4.50 through late summer 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. It’s 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 90 cents would collect 22.5 K. With a ten cent stop loss, the risk is 25,000.00 plus commissions and fees. Therefore a 2500.00 risk. One can sit with that collection and look to buy back with the goal of giving as little as possible back.

It is my opinion you would never have to absorb the loss with any of the short put spread trades, should the underlying futures not rally in the next 6 to 9 months, I can simply buy them back at or near break-even and roll them 3 to 6 to 9 months in the future well into 2021. In my view we will see a grain rally at some point of some magnitude in the next two years. From a mathematical standpoint, selling at a 80 to 90 percentile threshold of a no worse than a dollar move to me gives us the seller the greater probability of being able to buy back cheaper in the future. Again my opinion here. Please join me every Thursday at 3 pm Central for a free grain and livestock webinar. We discuss supply, demand, weather, and the charts along with trading ideas. A recording link will be sent to your email. Sign Up Now

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