What a bull market this has been. The Option Seller recommended put sales in the soybean market in both January and March. We hope you took advantage of the premiums.
For as we find ourselves on the brink of summer, it may finally be time to switch our focus in the soybean market to the overpriced calls now prevalent in this market. Not so much that soybean fundamentals have turned decidedly bearish. But more so because we seem to be in a bull market that has essentially "run it's course", especially in light of the outside "macro" factors now influencing many commodities prices.
Soybeans bull market this spring was due to a combination of tight near term supplies and voracious Chinese demand. Funds like trends. The trend in soybeans was clearly defined which brought more fund money, which in turn, drove prices higher. Fundamentals drive trends, for sure. But trends can also feed on themselves once they get going. The problem with this is that eventually, the music stops. And when it does, it often leaves the underlying commodity over (or under) priced, depending on the trend direction.
In this case, soybean prices may have gotten a bit ahead of themselves in May as evidenced by the correction in bean prices over the last few weeks. The brisk pace of Chinese demand isn't going to go away. But at some point, it's priced into the market. That is likely what is happenign now. And as summer growing season now begins in earnest, a number of factors are aligning which could hamper rallies and help accelerate the downside for soybeans.
1. Exceptional planting weather in the US midwest. It has been warm and dry - ideal. Soybean plantings are already at 87% complete as of the June 3 planting report. This is compared to 83% last year at this time. The 2012 soybean crop is nearly "in the ground."
2. Recent concerns emerging of slowing in the Chinese economy with data to back it up.
3. A commitment of traders picture that shows funds still holding a near record long position in soybeans. If and when they begin to liquidate, the selling could quickly feed on itself.
4. The renewed and ongoing crisis in Greece and Europe which could continue to pressure the Euro and strengthen the dollar (bearish for commodities in general)
5. A seasonal tendency for soybean prices to decline once the crop is "in the ground" and planting fears subside. This typically begins sometime in early to mid June.
The Seasonal Play in Soybeans
Of the factors mentioned above, perhaps the most considerable is the seasonal tendency of soybean prices to decline once the crop has been planted.
With Old Crop US soybeans running low and Brazilian beans not widely available on the market, the northern hemisphere spring often sees low inventories of soybeans and thus, higher prices. This price strength can often be given additional fuel by any weather concerns that arise during US "new crop" planting in the Spring. However as June arrives, new Brazilian beans are typically flowing back onto world export markets (Brazil's harvest is in April and May) and the US crop is usually safely in the ground. In the past, this has often pressured soybean prices into the summer months (see chart below). With this year's US planting well ahead of schedule, price pressure could come sooner rather than later.
Caption: While there are no guarantees it will happen this year, in the past, the combination of fresh Brazilian supplies and the end of US planting season have tended to pressure soybean prices into the summer months. (Past performance is not indicative of future results).
Higher Prices could help Call Sellers
For potential sellers of calls on these factors, it does not hurt that soybeans are still within $2 of their all time historical highs set back in 2008. This enables option sellers to target calls at strike levels this market has never attained - well above the all time soybean price highs. This week's technical rally is helping call premiums.
Caption: While weakened as of late, soybeans remain close to the all time high price levels set back in 2008.
Caption: The relatively high price of beans prior to summer means call sellers can target strikes at levels the market has never seen.
Conclusion and Strategy
While this week's technical led rally is pushing up call premiums again, it is our opinion that soybean prices will begin to weaken as the month of June progresses. The factors responsible for the rally this spring, while partially still in place, are being offset by both shifting soybean fundamentals and outside (Macro) market forces (see front page).
Look to take advantage of the relatively high price of beans while the volatility remains in the market. We like selling call premium well above the all time highs set in 2008. September calls are still viable. November will allow you to sell deeper out of the money strikes.
Whispers of warm dry weather this week are helping support prices. But these are normal this time of year. We will view limited weather rallies as call writing opportunities.
Example (ONLY an example)
Trade: Selling November Soybean 17.00 call
Target Premium: $600
Margin Requirement: $1155
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