While mainstream investors fretted over the fate of Europe this week, the agricultural markets in the US continued on a "business as usual" pace. They don't grow much corn in Greece or Italy. And prices, unlike those of stocks, gold or currencies, are more concerned with the old fashioned fundamentals. This time of year, that means harvest wrapping up in the United States. And if you are simply looking to sell options and collect premium, this short term type of investment can be a welcome change from the on again-off again Euro See-Saw of the past 2 weeks.
If you are interested in Selling Options for Income and Growth, the corn market can be a great place for beginners to start.
Corn prices got blindsided by a surprise in the September 30th Quarterly Grain Stocks Report. The September report is key for all grain markets as it sets the beginning stocks for which all 2012 calculations will be based.
Beginning stocks for crop year 2011/2012 were pegged at 1.128 billion bushels. This was 164 million bushels above trade expectations and above even the highest estimate. The build in supply was widely attributed to slack demand from China. That trend however, may now be reversing.
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"March 2012 Corn"
If you are unfamiliar with commodity fundamentals, ending stocks are the amount of commodity left in storage at the end of the crop year (September 1st). On September 1, the ending stocks from the previous year become beginning stocks for this year.
Ending stocks and Stocks to usage ratio (Ending stocks divided by projected usage) are the two key figures in price discovery of corn and most other agricultural markets. If riots erupt in Syria or a French bank becomes insolvent, the corn market generally only cares about how those developments could affect these two figures. Thus, agricultural markets are somewhat less adverse to geo-political events than financial markets such as stocks or currencies.
With the excess supply now priced into the market, there are now solid reasons to believe that the spike lower may have been the harvest low for corn prices. However, one of the many benefits of an option selling approach is that one does not have to pick the absolute highs or lows. With values still at relatively low levels, put sellers should get ready to begin their own harvest this month. Here's why:
1. Stocks are still Near Record Lows
Corn got it's bearish surprise in early October. With that now out of the way, the market can turn it's focus back to the bigger picture. Despite the recent adjustment to storage level estimates, US corn stocks to usage ratios for 2011/12 crop year were only adjusted up to 6.8%, still the second lowest in history. This means corn stocks will remain tight well into the Spring, when South American supplies become available. This base fundamental should add a strong layer of support to corn prices in the coming months.
Corn stocks to usage levels remain near record lows.
2. Seasonal Tendencies
As we continually reinforce in The Complete Guide to Option Selling, studying seasonal tendencies is one of the most powerful tools and option seller can use when taking premium in commodities. While seasonal tendencies are by no means a guarantee of future price movements, they do tend to reflect fundamentals that occur at certain times of the year. In the US, corn is harvested in the Autumn months. As a result, supply is often highest in the period immediately after harvest. Economics 101 tells us that higher supplies tend to favor lower prices. But as supplies go to market after harvest, inventories begin to fall again, and prices can often begin to rise. A seasonal chart of corn prices indicates that this tendency has been fairly consistent over the past 5 corn harvests. Will this year be any different? (Past performance is not indicative of future results)
3. China Demand could be the trump card this year
As of October 13th, US cumulative corn sales stood at 49.5% of the USDA forecast for 2011/12. The 5 year average for this point of the year is 34.4%. The primary reason the stats are running far ahead of estimates? China. As corn prices surged during the bull market of 2010/11, China released millions of tons of corn from state reserves, rather than pay inflated prices from exporters abroad.
China will likely be restocking state corn reserves well into 2012.
The strategy was to restock the reserves later, when prices were lower again. While corn prices have receded somewhat from early 2011 highs, they are not at levels that the Chinese would prefer to buy them. Nonetheless, China is now in a position where it must begin restocking state reserves. Corn exports to China in recent months have surged as the Chinese have been aggressive buyers of US corn on dips below $6.00 per bushel. China buys at these levels for one reason: They don't see it getting much cheaper. It is likely that the USDA will now have to raise export estimates in the November USDA Supply Demand report as a result of brisk demand from the Chinese.
Conclusion and Strategy
With any future bullish surprises from the USDA likely on the upside (there are now rumors that yields will be cut in the next report), a potential "harvest low" in place and projections for strong exports ahead, the risk of a large scale move in the corn market is likely on the upside, not the downside. In addition, should the macro-picture shift it's focus back to bearish economic indicators or the next chapter in Europe, corn and agricultural prices tend to be least affected by such macro events. Food demand, especially "core" foods like grain, tend to be last to suffer, and suffer the least from economic downturns. This is key for put sellers who care not so much that prices rise - but only that prices do not decline precipitously.
We therefore see put sales in corn as a high percentage play to pad portfolios with premium this month, regardless of what the economic outlook is, or changes into.
We will be working closely with clients to position managed portfolios in November. If you are attempting to position on your own without guidance, look to the March contract to strike the right balance between distance from the money and fast time decay. The right strikes will be below the October lows.
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