The corn market has been pretty exciting in the past few months and has brought some great trading opportunities. Prices have been moving up substantially. In mid-June through early July, prices had bottomed around $3.50 a bushel, and then the market began heating up. Corn is currently trading around $5. The question is now, where do we go from here? And how do I take advantage of the next move?

Each corn futures contract equals 5,000 bushels. A one-cent move is equivalent to $50, so the move we have seen late this summer has been fairly substantial. The rally has been supported by lowered crop projections from the U.S. Department of Agriculture, as well as a weak U.S. dollar. Since the U.S. exports a lot of corn, a weaker dollar makes buying corn more affordable for foreigners. There have been (unsubstantiated) rumors that Russia might consider purchasing U.S. corn, and there have been some flooding problems in the upper Midwest growing areas.

Fund market participants have been strong buyers of corn. The Commitments of Traders Report for the week ending September 21 from the Commodity Futures Trading Commission showed funds were net buyers of more than 11,000 contracts, boosting their net long position to a new high of almost 360,000 contracts.  That doesn’t mean they will continue buying, or that these prices will continue to rise, however. Actually, I don’t think the bull run is likely to continue.

As farmers head into harvest, I expect yields to increase. More supply has a potential to bring prices down. Farmers are more likely to sell than store their crop to lock in current prices.

How can you position yourself as a trader, if you aren’t sure where the market is headed next? It’s possible to play both sides of the market with a carefully planned option strategy. That is, you have the potential to profit whether prices go up or down.

The Ratio Spread
Here’s what the strategy entails. You would buy a December $5 corn put, which was trading at about 21 cents on September 27, 2010. So 21 cents x 50 = $1,050. That’s the cost of the option to you, not including commission charges. Then, you’d sell two December $4.60 puts, to create a bear ratio put spread. You collect about 16 cents in premium for the two $4.60 puts. Your net option premium cost is therefore 5 cents to get the trade on.

If the market starts to sell off from $5 to $4.60, your profit potential is 40 cents. So, 40 cents x 50 = $2,000 potential profit. Your “sweet spot” is $4.60; that’s where you want to the market at expiration for the put side of the trade. This trade does have unlimited risk on your one naked $4.60 put.

Let’s figure the breakeven and see how this plays out if the market moves against you. Your breakeven is at $4.20, ($4.60 – 40 cents you make from $5.00 to $4.60; subtract it from $4.60 for your one naked put and you arrive at $4.20). Then you need to add the cost of the option premium so add 5 cents to $4.20. Your optimal (profitable) range is for corn to trade is between $4.95 – $4.25. As corn moves under $4.25, you start losing money, and you’d have unlimited risk to the downside on your one naked put. However, you have to ask yourself how low will the mkt go in two month’s time, November 26th is option expiration.

So let’s look at the call side of this strategy. You would buy a December $5.20 call, and pay 26 cents in premium. Then you’d sell two $5.80 calls and collect in 24 cents in premium. You are paying 2 cents or  a net of $100 in option premium.

Your breakeven is at $6.38 on the upside and $5.22 on the downside, so your desired range on this part of the strategy is from $5.22 to $6.38. Your sweet spot is $5.80, which would net you $3,000, not including the premium paid or your commissions.

If you pursue both the call and put sides of this strategy, your risk lies in one naked $5.80 call and one naked $4.60 put. However, the market can’t be two places at once, so one side or another will expire worthless and you won’t have to deal with that side of the trade.

If you have a bias, you can play one part of this strategy if you wish. But if you aren’t sure which direction the market will break out, this strategy can offer a way to play both sides.

Please feel free to call me to discuss this strategy in further detail, or with other questions you might have about the markets.

Mike 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.

Futures trading involves substantial risk of loss and is not suitable for all investors.

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