Market Commentary for 3/28/14
The prognosticators who preached “oats knows” a few weeks ago are noticeably silent following the recent $1/bu market collapse in the oats market. In the last 30 days oats ran up $1/bu and then back down $1/bu. This oats drop was largely due to the fact the funds were liquidating their positions over the last week or so. What about corn could the funds who have the biggest long position in 14 months do it in corn? With spring approaching southern feed mills will be cutting back on grain purchases and shifting to grass-feeding their cattle. The ongoing concern with the PEDV virus is putting pressure on hog feed demand. At this point, poultry is the only consistent animal market. Ethanol margins and exports have remained firm helping support the current market prices.
Expect the Monday USDA report to send fireworks through the market (11AM). Last year corn dropped in price after this report. Since 2001-2002 corn prices haven’t decreased two years in a row after the March report. Another interesting statistic, in the last 10 years, the USDA has increased total planted acres from the March report to the June report 9 times. Typically estimates from this report vary widely, so the market will probably overreact in either direction. Knowing this, it reinforces why it is important to have your goals in place now, knowing what you want in the market over the next year. Having an order in place is always wise. Nobody in the trade has a good feel for this report. The only thing many in Chicago agree on is they think the report will be a limit move in either direction.
As mentioned previously, old crop may get volatile due to global export demand. Chinese cancellations and imports from South America will drive this. Similar to corn, new crop prices will adjust to the USDA acreage estimates. There doesn’t appear to be any historical trends in the soybean market with the March USDA report. Predictions by traders are wide (even more than corn ranges). Hang on tight, I could be a wild ride Monday.
Are You Naked Going Into the March USDA Report?
As mentioned above, the March report could send ripples through the market. There are ways farmers can protect themselves against price volatility and reduce their risk. However, most do not and leave themselves exposed (i.e. naked). Following is a detailed explanation of a trade I just did that illustrates how a farmer can protect themselves against price fluctuations caused by this report.
I predict that farmers will plant a significant amount of soybeans considering the recent decline in corn prices and the steady price of soybeans. If yields are similar to last year (which wasn’t ultimately as good as expected and are less than current guess for this years crop), there will be double the amount of carryover beans (old crop being “carried over” or sold after new crop is harvested) next year (Fall of 2015). If this happens, it will cause a strain on the current market rally. So, I am estimating soybeans have hit their peak and will trend down. But, as always, it’s difficult to predict future prices of the market. So, I want to keep my positions flexible. There is a possibility the USDA will surprise the market with lower planting intentions causing the market to rally. I want to be prepared for both scenarios.
Recently the CBOT introduced a new “tool” (in the last year or so) that will help with this trade called “Short-Dated Options.” These options allow for shorter windows of coverage for less money. For instance, you can buy options based upon Nov futures that EXPIRE on April 18th that cost less than regular options. Few farmers know about this news tool, let alone how to use it. (The saving today on a short dated call was about 66% of a straight Nov option.)
Earlier this week with the upcoming March USDA report I wanted to place protection against my 2014 Soybean production. So, I sold some Nov Futures at $11.77 (the equivalent of 20% of my bean crop). I then paid for two “short-dated” calls (the right to buy grain at that price) at $12.10. The cost for each of these calls was $.12/bu ($.24/bu total). In other words, I spent $.24/bu to buy beans on or before April 18th for the price of $12.10. Why would I do this?
Scenario #1 – As anticipated, estimates on the USDA report show a high number of soybean acres planted – prices plummet – let’s assume to $11.
If that scenario happens between 3/31-4/18, I will get $11.53 guaranteed for new crop (Nov). That is the $11.77 futures that I sold less the $.24 for the two short-date calls. So, I’m protected against the bottom of market price of say $11 (or even lower).
Scenario #2 – The market is surprised by low soybean planted acres – causing a price rally – let’s assume to $12.50.
If that happens between 3/31-4/18 on one of the calls I will be able to buy back the futures I sold for $11.77 against Nov at $12.10 (the “strike price” of the calls I mention above). This is a loss of $.33 + the cost of the call ($.12). Total loss: $.45/bu. However, I still have that second call at $12.10. So, I can either sell those beans (in the form of a call) for the $12.50 or hold them if I think prices will go up (I have choices). If I did decide to sell at $12.50 on or before 4/18, the second call is a $.40 profit (less the $.12 call cost) – or a net gain of $.28. So combined together, my net position would be a loss of only $.17. But I still have my beans from production that I can sell now. Meaning, I would still make $12.33 on my beans (versus the $12.50 high). This is a complicated way of saying that if bean prices rally I can still take advantage of the price increase, but have to sacrifice $.17 to protect myself against the possibility of scenario #1 (a real possibility).
Scenario #3 – Things get crazy and prices go to $13 by 4/18
Refer back to scenario #2 and instead of the second call making $.28 it would make $.78. Thus I could actually make more on my beans than what the market gives me. $.78 profit -$.45 cost of the first call nets me $.33 and I still have my beans that could be sold at $13 + $.33. (it’s the “home run” situation)
Scenario #4 – The market does nothing and is basically unchanged.
The calls will lose 50% of their value after the report because the risk of the unknown will be greatly reduced. I might have the opportunity to liquidate the long call position and only lose about $.12.
To summarize, with this option my lowest bean price going into April is $11.52 with unlimited upside potential (less the $.24 call cost at and the spread between 11.77 and 12.10 at most but likely it will be in between).
Do you see how I significantly reduced my potential risk with this report? I am playing both sides. If the market plummets, I have a safety net. If the market rallies, I get to take advantage of this too (for a small cost). By not putting these types of safeguards in place, most farmers are leaving themselves “exposed” to the whims of the market and don’t realize that they can control their position to an extent by taking advantage of market tools in the face of market volatility and the unknown.
If you’re interested in learning more about these types of options for your farm operation call me.
Check back on the enewsletter on 4/18 for I’ll explain how this all played out.
More Market News…