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A Bearish Commodity Trade on Soy Complex with Mitigated Risk

03/02/2018 3:46 pm EST

Focus: FUTURES

Carley Garner

Senior Strategist and Broker, DeCarley Trading, LLC

Commodity trading gets a bad rap due to the risk involved in the futures and options markets.  But the reality is, the risk can be as aggressive or conservative as the trader’s imagination allows, says Carley Garner, senior strategist for DeCarleyTrading.

More importantly, it is the trader himself who is in control of leverage and risk, not the market. There are several strategies involving long and short futures and options that create reasonable risks and precise speculation.

We were reminded of this today while attempting to construct a bearish trade on the soy complex. 

There are multiple signs of a looming ceiling in the price of soybean futures, and thus soybean meal futures. 

Yet, anybody who has been around the commodity markets for any length of time knows that establishing a bearish futures trade in soybeans is an accident waiting to happen. Still, there appears to be an opportunity to play the downside in an over-extended market that rarely holds gains made in February rallies. 

Perhaps a trader can get the best of both worlds.

Hedging Futures with Options

chart

Chart source: QST

Soybeans, and therefore soybean meal (CBOT:ZM), have had a nice run. However, late winter runs in this complex are typically followed by weakness.  Further, both RSI and Williams %R suggest the market is overheated and due for some back and fill.

A trader could wager on the downside in soybean meal using a covered put strategy. Specifically, selling the May soy meal futures (SM) contract near 393.0 then selling a 395 put option for about 16.00 ($1600).  To protect against a runaway rally, we also recommend purchasing the April 430 call for about $170.

In the end, we have a trade that could potentially make money if held to expiration regardless of whether the market goes up, down, or sideways. 

However, the least stressful scenario would be a decline from here. If everything is held intact and the futures price is at, or below, 395.0 this trade stands to make roughly $1,200. The risk at the time of the April expiration is not quantifiable because it depends on volatility and demand, but should be well below $2,000.

Once the April options expire, if the protection is not replaced, the risk is theoretically unlimited. Nevertheless, as long as the price of meal is below 410.0, at May expiration the trade pays off something.

In summary, if this strategy is correct by a single tick, the trade pays off over a thousand dollars. If the trade is wrong by less than $1.20 in soymeal (a decent amount of room for error), the trade still makes something albeit diminishing as the price climbs. The only scenario in which this trade loses money is if the market is above $4.07 at expiration.

There are no guarantees in trading, nor are their stress-free ventures, but this strategy offers attractive odds with mitigated risk.

There is a substantial risk of loss in trading commodity futures, options, ETFs.  Seasonal tendencies are already priced into market values.

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