Corn has been moving up with other commodities in recent days as hope springs eternal for an economic turnaround, and I think the market is looking bullish heading into the March 31, 2009 USDA Planting Intentions Report.
May corn futures rose above $4 a bushel on Monday, March 23, 2009, after posting a fourth straight weekly gain. I think this market is setting up to move even higher and I recommend an options strategy in July contracts to take advantage of the trend into growing season.There is a lot of concern about inflation right now, and that’s attracting speculative buying. We are starting to see farmer selling lighten up in anticipation of higher prices. Outside markets are supportive as well. The stock market saw a huge rally on Monday, March 23, after the Treasury announced plans to purchase $1 trillion in toxic bank assets, and the U.S. dollar headed lower. Increased fears of inflationary pressures resulting from stimulus measures are having an impact on commodities, including corn.
Trend-following funds are starting to move to the net long side in corn after being short for about three or four weeks prior, and I think that’s encouraging. According to the latest Commodity Futures Trading Commission’s Commitments of Traders Report, trend-followers were net buyers of about 35,000 contracts, which made them net long approximately 11,600 contracts. Back in late February, these traders were net short by about 60,000 contracts. Certainly we are seeing things turn. Index funds were small net buyers of about 1,400. Hedge-fund managers and other large speculators more than doubled their net-long positions in corn futures and options to 66,801 contracts in the week ended March 17, the highest in five months, from 30,395 a week earlier. That’s up from a 37-month high of 13,117 contracts in net-short positions on Feb. 17. Fund managers held a record net-long position of 346,768 in Feb. 2007.
Also supporting higher corn is the fact that input cost for growing the crop are starting to head up, namely fertilizer and crude oil. Crude oil has recently rallied above $53 a barrel. These input costs are rising, and that is going to cause farmers to reassess what their profit target is.
Technically, we are seeing momentum indicators such as the Stochastics and Relative Strength Index (RSI) are getting slightly overbought conditions, but that doesn’t mean the market can’t continue higher. Take a look at the daily chart of July corn with the 8-day, 21-day, 50-day and 200-day moving averages. We’ve seen some crossovers in our moving averages; the eight-day moving average came over the 50-day and the 21-day, a bullish indication.
The full-sized CBOT corn contract is a 5,000-bushel contract, and each penny move equals $50. There are a variety of strategies you can pursue into spring planting season, but one I think looks promising right now is a long bull call spread with a short put. You would buy $4 July corn calls, and also sell the $4.50 call and sell the $3.50 put. By selling the $4.50 call and the $3.50 put, you help finance the purchase of the $4.00 call and if you can get this trade done at even money, your costs are totally offset (not including commissions). What we want to see is for the market to move above $4, that’s where this trade becomes profitable as $4 is our breakeven point. You need to be aware that your risk can be unlimited on the $3.50 put. However, I don’t think corn will head under $3.50 before expiration of these options on June 26, and at any rate, the farthest the price of corn can go is to zero. That doesn’t seem very likely, in my opinion, as no one will give corn away.
The March 31 USDA Planting Intentions report will give us an indication of what acres farmers will plant this season. Given the recession, acres are expected to be down, as seed sales are down. However, we always have weather at play, and North Dakota has gotten extensive flooding that could potentially reduce acres or delay planting. I think the market should find support at $3.50 and has good potential for a run to $4.50 or even $5. If that happens, each of these trades could be worth $2,500. If corn sells off but is above $3.50, you don’t make anything on the trade, and would only lose your transaction costs.
Statistically speaking, research has shown about 80 percent of all options purchased and held to option expiration expire worthless, which is why I recommend incorporating options selling into the strategy. As the seller of the $3.50 put and the $4.50 call you have the potential to keep all or some of that option premium.The margin requirements on an outright corn futures contract requires $2,025 initial margin, with maintenance margin at $1,500 (margins subject to change). This strategy I described using options would be $1,229 initial and $910 maintenance. The exchange offers a margin reduction on this type of options strategy, which may be of benefit to you. Again, you certainly have to be mindful of the risk on your naked $3.50 put, if the market should take a big nosedive, you could suffer a significant loss.
This type of options strategy is a good one for a sideways to higher markets, and it gives you room in case corn meanders a bit. Expiration on these options is June 26. If corn moves above $4.50 before then, you may certainly opt to take off the trade prior to expiration. You won’t realize the full potential, but could still realize a nice return.
If you’d like to learn more about this topic or to develop a customized strategy for other markets, please don’t hesitate to give me a call.
Mike Sabo is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted division. He can be reached at 800-798-7671 or via email at msabo@lind-waldock.com.
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