by Michael Sabo
Corn has made an impressive run, hitting $7.68 a bushel on April 11, 2011, its highest level in more than two years. Looking back to June 2010, corn was trading around $3.80 a bushel, so this market has been good to the bulls. Year-to-date, the market is up 20 percent. The big questions for most traders are: how high can it go, and how can I trade this market as we head into a potentially volatile growing season?
There are several ways to trade corn, one being futures. Corn futures are traded at CME Group, and the market has both healthy volume and open interest. As of this writing, open interest stood at about 530,000 contracts, and volume stood at about 136,000 contracts. Every one-cent move in corn futures (from $7.60 – $7.61 for example) represents $50. It is 5,000-bushel contract. Current initial margin to initiate a futures position is $2,363 (subject to change without notice at any time).
All futures contracts allow you to utilize leverage, which is a feature many traders and investors find attractive. If corn is priced at $7.60 a bushel, you are leveraging over $38,000 worth of corn for less than $2,500 in margin. Of course, this type of leverage can work against you, magnifying both losses and gains if the market moves against your position. You can lose more than your initial investment when trading on margin.
If that type of leverage seems a bit too daunting, there are different ways to approach trading. You could chose to not utilize the maximum leverage you are allowed, instead putting up more than the initial margin. There is also a mini-corn contract based on 1,000 bushels. Since it’s one-fifth the size, the required initial margin is also one-fifth the size. In the mini-corn contract, every penny move represents $10.
You can also trade options on corn futures. The most simple of strategies involves buying call options if you believe prices are moving up, and buying put options if you believe prices are going down. Some of the advantages of buying options are that you can have a lower margin cost to initiate the trade (or have no margin), you can define your risk to a predetermined maximum loss (depending on your strategy), and you can better weather market volatility without getting stopped out of your position. I will outline a more complex options strategy that involves simultaneously buying and selling options, but first, let’s look at some fundamentals.
The market is looking a bit over-extended right now, but I remain bullish and believe prices should remain firm. Will corn hit $10 this growing season? I don’t know how high it ultimately could go; I don’t like to try and pick absolute tops or bottoms. But demand for corn seems to be coming from everywhere, from food to fuel, and corn is a commodity that is planted in the ground in a finite amount each year. The weak U.S. dollar has also supported gains in corn. As corn is priced in dollars, the weaker dollar makes it cheaper for foreigners to buy more of it. I don’t see a change in the weak dollar policy any time soon.
The latest USDA planting intentions report showed increased corn acreage planned for this season (92.18 million acres), but it still might not be enough to meet demand and was below what traders were expecting. Weather is a big wild card for grain markets this time of year. You never know what spring planting will hold and already people are talking about less-than-favorable conditions causing planting delays. I can’t even begin to speculate on how good or bad the growing season will be, but it’s fairly uncommon to find perfect growing conditions across the main producing regions, and stresses reduce yields especially when it happens early in the growing cycle.
I do think prices will stay firm during the North American growing season. Short-term, this market looks a bit overbought, and on Wednesday, April 13 the market saw an inside session, trading within the prior days highs and lows. Inside sessions tend to reflect consolidation periods. However, technically, the market has remained above its 50-day moving average, which looks bullish.
Options Strategy for Corn
I would like to outline a bullish options strategy that allows traders to weather some of the volatility we’ve seen in these markets and still hold a position over the next two months. Let’s look at a strategy involving July corn options, which expire June 24.
Buy one $7.00 call (88c cost)
Sell two $8 calls (78c premium collected)
Sell one $6.50 put (12c premium collected)
When you net out what you paid for the call and the premium you collect selling the puts, you have a credit of about 2 cents on the trade, or $100, not including your commission costs. Margin is about $1,736 to initiate this trade (prices and margins are subject to change and are given for the purposes of example only). Why consider this type of trade? You have the opportunity to be long corn at $7, which is desirable if you are bullish but would like to buy at a lower level then the current market’s price. The premium you collect finances the trade, so your cost basis is essentially zero, not including your commissions.
The $7 call is currently in the money, so if you held it to expiration at current levels ($7.56); it would be worth approximately $2,800. Now as long as corn is above $6.50 a bushel and below $7.00 at expiration, a trader would not make or lose anything.
Corn can pull back quite a bit before this trade is in the losing column; this strategy may provide you some room for the market to pull back between now and expiration and keep you in the market. Your breakeven on the upside is $9, and $6.50 on the downside, so the goal is for corn to be priced between $7 and $9 at expiration. The sweet spot is $8—that’s where you want the market to be at expiration to net you the most favorable results (with $8.00 corn at option expiration, the trade is worth $5,000 per option strategy). This position is not without risk and is not for all investors. It’s important you have a good understanding of options if you’d like to explore such a strategy, and I recommend you work with a professional if you don’t.
Your risk lies in one naked $6.50 put and one naked $8.00 call (BUT the market cannot be in two places at once). The risk is potentially unlimited. However, it’s unlikely the price of corn will hit zero in less than two months, and it’s probably also pretty unlikely it will move above $10. There are ways to manage the risk if either of these scenarios looks as if it could unfold. This strategy is not to be construed as a specific trade recommendation for all investors, but rather, an example of how options can be used.
Please feel free to call me to discuss this strategy in further detail, or with other questions you might have about the markets.
Michael Sabo is a Senior Market Strategist with Lind-Waldock. He can be reached at 800-798-7671 or via email at msabo@lind-waldock.com.
Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder. Futures and options trading involve the substantial risk of loss and is not suitable for all investors. © 2011 MF Global Holdings Ltd. All Rights Reserved. Lind-Waldock, 141 West Jackson Boulevard, Suite 1400-A, Chicago, IL 60604. www.lind-waldock.com
