A Simple Corn Trade Using Options
04/22/2011 6:00 am EST
One trader has uncovered a July option contract for corn that may pay a sizable premium to those who simply let corn’s ultra-bullish fundamentals stay in play and maintain the higher prices we’re seeing currently.
When it comes to option trading, most traders who are bullish buy the calls, while those who are bearish buy the put options. Seldom do they sell calls or puts to someone else looking to profit from option premium decay.
If your research tells you a market will trade higher in the months ahead and a call you buy will be profitable, then the put you plan to sell will be equally as profitable, if you are right.
One market offering handsome return probabilities on selling a put is corn. Corn got to record high prices this month on the back of a series of bullish fundamentals that can't change until after the planting yields come out in late-July for the crop being planted.
At the end of our grain marketing year on Aug. 30, the US corn stock is estimated to be at 675 million bushels, or about a 15-day supply, according to the USDA’s April crop report.
Essentially, the report says that the US is nearly out of corn unless this year's crop sees near-record yields on better-than-perfect weather.
Demand for Corn
Asia and ethanol producers are demanding more corn. Ethanol production is consuming five billion bushels, or about 45% of our crop, as compared to 2001, when only 600 million bushels were used for ethanol.
So, corn needs to hold a price premium until it passes through its key pollination stage when yields are largely determined. Even then, corn needs to hold a reasonably high price through year-end into next year to ensure demand doesn't again outstrip any increase on ending stocks.
How to Profit
Consider this: July futures have been trading the last eight days between $7.40 and $7.88. Be sure to check for updated pricing, but at the time of writing, you can sell a July $6.40 put for 14-18 cents, or $700-$900 premium paid to you.
The options expire the third Friday of June. It would have to drop more than $1.20 per bushel just to get to the $6.40 strike price when corn yields will be entering key yield development time, and a weather premium should still be priced in.
If July futures are more than $6.40 when the options expire in June, you pocket the entire premium paid to you.
By Tim HannaganTim Hannagan is senior grain analyst at PFGBEST. He has more than 30 years of experience as a futures and options trader for retail accounts. Every day he publishes analytical research reports at pfgbest.com/research.