We are seeing a lot of volatility in the commodities markets right now, and that creates a lot of challenges for traders. I’m going to outline an options strategy you can pursue when markets are volatile, using corn as an example. You can apply this type of strategy to other volatile markets too.
Traders are finding it difficult to hold their positions in the sort of environment we are in, and are getting chopped up. The market gives a buy signal one day, then a sell signal another day. Let’s take a look at corn.
March 2010 corn closed at $3.83 ¾ cents per bushel on Monday December 7. Corn has fallen five sessions in a row. It took a big hit on Friday, December 4, when the U.S. dollar spiked higher after a stronger-than-expected November employment report. The dollar has been influencing commodity prices, and traders should be focusing on it.
Despite the recent setback, I think the fundamentals for corn support higher prices. There is still a quality problem from this year’s crop. I think the dollar weakness will resume in early 2010, and that should help export-driven commodities rebound. China continues to be a big commodity purchaser. In addition, soybeans have been outperforming corn, and cheaper corn can be used to some degree as a feed substitute.
Corn futures are running into resistance around $4.20. This market has broken down in the past few sessions, but I don’t think it will completely fall apart. Longer-term prospects look more bullish. To establish a long position in this market without the risk of getting stopped out amid all the chop, you can trade options. If you take an outright futures position, you are facing a lot of risk given the volatility.
In March corn, $3.60 looks like strong support, so I recommend selling March $3.60 corn puts, which were trading at about 13 ½ cents as of the close Monday, December 7. Then, you would also buy a $4 March corn call, with the idea corn prices will move back up. That call was priced at about 28 cents as of Monday, December 7. Then, you’d also sell one $4.50 corn call, trading at about 7 cents. So, you sold a naked put, and bought a bull call spread.
With this strategy, you collect premium of about 20 ½ cents, and paid 18 cents for the $4 call. You end up with a 2 ½-cent credit, or $125 for the trade, not including your commission costs. As long as the market holds $3.60 and is below $4 at expiration, you don’t make money on this trade, but you don’t lose any either. Any move above $4 at expiration, and this trade would be profitable. If the market is at $4.50 or higher at expiration, you make 50 cents, or $2,500.
The risk in this strategy lies in the $3.60 put, which faces unlimited risk, just as an outright futures position would. However, the worst it can go to is zero; no one is likely to start giving corn away for free. Corn isn’t likely to be completely worthless. And, you do have time to act, or react, if the market goes against you in this position. You could unwind this trade before expiration. And, for an options trade like this, margin is also about half of what you’d need for a futures contract. So you could get a little more bang for your buck if the market moves in your favor.
This strategy can be used in other markets as well. What happens when markets pull back, such as we’ve seen in gold recently, is that premium typically increases for puts, and decreases in calls. So this type of strategy works well in this environment, for corn or for gold. You are selling puts, so you want to collect a high premium, and you don’t want to pay as much for your near out-of-the-money call.
This is only a brief overview of one strategy in one market you can apply to volatile conditions. Feel free to give me a call with any questions you might have about this topic, or for other market-related information and strategies.
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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