Option sellers seeking a solid market for premium collection this month need look no further than the basic commodity of corn.
I recommend this market to clients often as the fundamentals are concrete. It lends itself well to price projection if you know how to crunch the numbers.
The long story short for option sellers this week is this: Corn, like many agricultural commodities, has seen an explosion in demand in just the past 5 years as China, India and other emerging economies increase populations of both people and livestock. The Chinese alone have seen corn usage increase over 28% since 2006. China used to be a leading exporter of corn and rival to the US for the world's corn business. Now, it's surging population means it can't even grow enough to feed its own people. China will be a net importer of corn this year by nearly 7.5 million tons.
China and other emerging economies have seen demand growth surge in the past 5 years.
Global corn growers have made strides in production technology that has enabled many to nearly keep up with demand. But not quite. And that shortfall has resulted in the lowest stocks to usage ratio (end of year leftover corn supply vs. projected upcoming year demand) in over 30 years. In short, supply is tight this year and corn prices will be sensitive to any weather threats to US or Chinese crops this summer.
Can you predict tomorrow's price with this information? No, you cannot. But it's sets the backdrop for the market and identifies the playing field in which you are preparing to collect premium.
Growing demand for corn has resulted in the lowest stocks to usage figure in over 30 years. In short: An extremely tight supply situation as the 2012 US growing season starts.
The Paradox of Planting Season
April marks the beginning of planting season in the US. This can often be a time of high anxiety for corn traders as any weather delays or disruptions to planting can bring price strength into corn. However, corn has yet to stray from it's relatively benign 1.00 trading range for over 6 months. With low supplies and strong demand, why are prices not rallying?
A few reasons.
1. Corn prices, from a historical perspective, remain relatively high (See Monthly Corn Chart below). At some point, even with tight supply, prices reach an equilibrium. We could be at those levels now.
Corn prices remain relatively high from a historical perspective.
2. Farmers in the US shifted acreage away from soybeans and into corn for their 2012 planting intentions. While this is still subject to change, it has tempered bullish enthusiasm for corn in the short term.
3. The warm winter and spring in the central US means fields thawing earlier. This means planting starting earlier. The April 15th planting progress report shows US corn plantings already 17% complete compared to only 5% last year at this time. The 20 year average? 6%. Off to a good start indeed.
Can we conclude that corn prices will remain near current levels through planting season? No. We cannot. Planting season has just begun and will likely not completely finish (have a "crop in the ground") until early June. Much can happen in that time and the bears know it. Do not underestimate the power of weather scares when supplies are this tight. At the same time, for those that read The Complete Guide to Option Selling, you learned one particularly useful nugget when trading agricultural markets: Never bet on a weather scare.
So how does this uncertainty make a top market for selling premium this month?
Conclusion and Option Selling Strategy
Remember as an option seller, you don't have to pick what the market is going to do, only what it is not going to do. In the case of corn, a relatively stable trading range has been established between 5.70 and 6.80 per bushel. A perfect planting season is rare and we do not expect one this year. The tight supply situation should keep corn bears at bay for some time, at least until the new crop plants begin to emerge in June. We think the lower end of the range is safe for now and puts sold far beneath those levels should be excellent equity producers for their sellers.
September 2012 Corn
A rally towards the top of the range or even a breakout next month can likely be viewed as a call selling opportunity at that time. Deep out of the money calls, likely in the September or even December contracts should be favored. That would effectively give you a strangle on the corn market. Corn prices have historically begun to weaken by late May as planting nears completion. This should hinder rallies the closer we get to June.
Note: The opinions presented here are that of Liberty Trading and not necessarily shared by Optionetics and/or its instructors.
James Cordier & Michael Gross
Contributing Writers, Liberty Trading Group/Optionsellers.com
Optionetics.com ~ Your Options Education Site