Selling Carry and Time
What’s happened…
The grain complex (corn, soybeans, and wheat) is entrenched in a bear trend of lower prices. Over the last year, market conditions moved from an inverted situation to a carry situation. This means that front month futures were trading at a premium to the back months. This inversion has since disappeared. The market is currently not as concerned about old crop inventories, with prospects of increasing supplies for new crops in 2023. Consequently, carry (cost of storage, insurance, and interest), is being added back into price for new crop contracts. In other words, the market is telling farmers to store your grain, as the deferred months are worth more than the front months.
Why this is important…
The problem with carry markets is that they are reflective of larger supplies. Unless end users are enticed to rapidly buy physical supplies, or the market has some reason to believe that supplies need to be rationed, the carry in the market tends to encourage producers to store. If a bullish scenario doesn’t develop, the deferred months may eventually lose value, often going off the board where the initial front month stopped trading. The concern in the corn market this year is that farmers have been light on selling ahead. Consequently, they could likely move a lot of corn into the harvest window. This keeps pressure on the front months as well as basis. The back months have carry. Will they eventually decline as well?
What can you do?
Selling call options is a strategy to either add premium to your account or be willing to accept a hedge at a higher price – or both. Let’s run a scenario as an example: if the front month futures are trading at $4.80 and a deferred month is trading at $5, there is 20 cents of carry charge. Let’s say the $5.50 call on the deferred month is trading for 15 cents. (By selling a call option, you collect the premium.) A $5.50 call means that, if corn futures at option expiration are below $5.50, the call option will lose its value. If futures are above $5.50, the option will be exercised if you did not purchase it back. An exercise means the short call option is converted to a short futures at $5.50. Your unpriced inventory that you had stored in this scenario will be hedged at $5.50 plus premium collected. Since cash was unpriced, a futures rally will likely mean a gain in the cash market.
This strategy could be contemplated on a portion of your bushels targeted for storage. Selling call options requires margin requirements, which means cash must be available to meet margin calls that are likely to occur with short options. Have a conversation with your advisor. All strategy, including doing nothing, has some form of cost, risk, or both. Make sure you review all potential outcomes before entering any position.
Editor’s Note: If you have any questions on this Perspective, feel free to contact Bryan Doherty at Total Farm Marketing: 800-334-9779.
About the Author: With the wisdom of 30 years at Total Farm Marketing and a following across the Grain Belt, Bryan Doherty is deeply passionate about his clients, their success, and long-term, fruitful relationships. As a senior market advisor and vice president of brokerage solutions, Doherty lives and breathes farm marketing. He has an in-depth understanding of the tools and markets, listens, and communicates with intent and clarity to ensure clients are comfortable with the decisions.
The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Individuals acting on this information are responsible for their own actions. Commodity trading may not be suitable for all recipients of this report. Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Examples of seasonal price moves or extreme market conditions are not meant to imply that such moves or conditions are common occurrences or likely to occur. Futures prices have already factored in the seasonal aspects of supply and demand. No representation is being made that scenario planning, strategy or discipline will guarantee success or profits. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Total Farm Marketing. Total Farm Marketing and TFM refer to Stewart-Peterson Group Inc., Stewart-Peterson Inc., and SP Risk Services LLC. Stewart-Peterson Group Inc. is registered with the Commodity Futures Trading Commission (CFTC) as an introducing broker and is a member of National Futures Association. SP Risk Services, LLC is an insurance agency and an equal opportunity provider. Stewart-Peterson Inc. is a publishing company. A customer may have relationships with all three companies. SP Risk Services LLC and Stewart-Peterson Inc. are wholly owned by Stewart-Peterson Group Inc. unless otherwise noted, services referenced are services of Stewart-Peterson Group Inc. Presented for solicitation.
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Bryan Doherty