Consider Bull Call Spreads Amid Grain Run
The grain markets have seen some sizable moves, and the volatility can be tough to handle as a trader if you aren’t well capitalized. However, there is a way to get involved in these bullish trends in a more conservative manner, using options. I am recommending using options to capitalize on markets I feel offer continued upside potential—soybeans and corn.
You can use options to help you participate in volatile markets showing an upward trend, without getting washed out of a trade when short-term corrections occur. Many people open accounts with the desire to trade grains, and while they have the right ideas about the market’s direction, the volatility wipes them out. The types of moves we’ve been seeing in these markets lately can be quite costly to maintain on a day-to-day basis.
Grains have seen some big moves, and the fundamentals and market conditions now are out of whack. The fundamentals and technicals are not really justifying the type of gains we’ve seen. The South American harvest looks favorable, and we're just entering our growing season in North America.
Investors have been looking for alternative places to park their money as the equity markets haven’t been performing well. Fund money has been flowing into commodities overall, including grains, softs, metals and energy markets. Investors are taking their money out of the stock market and allocating some of it to commodities, which is a rather new market dynamic that’s helping to inflate commodity prices overall. Of course there are factors like the weaker U.S. dollar driving up commodities, but we can’t ignore the fact that capital is flowing into commodities in greater amounts than before. Hedge funds and other large market participants seem to be using commodities as a safe haven of sorts, as the inflation story continues to make headlines, and commodities continue to feed on it.
Soybeans
Soybeans have certainly been volatile lately. This market had seen three limit-down moves in a row, falling to a three-week low. Soybean futures had declined their downside limit of 50 cents in overnight trading Sunday March 9, but as the regular daytime session got underway Monday, the market staged a sharp recovery to close with only a minor loss on the session. On Tuesday, March 11, soybeans recovered to close higher on the day, up 1 1/4 cents at $14.07 3/4 . It’s been an exceptional recovery. Markets certainly do see shakeouts within the overall trend, and soybeans will likely see some corrections too. However, several times we’ve thought the top was in—only to see the market keep rising to new heights. This is a powerful trend.
I see more room for soybeans to rally, and think prices could hit $16 per bushel by the beginning of May. I recommend buying July 1480 soybean calls, for 75 cents, or $3,750 excluding commissions. These options expire on June 20, 2008. I’d also recommend selling 1540 calls at 62 cents, for $3,100, not including commissions. So your defined risk is $650 on this trade (your total cost), and you have a potential to gain $3,000, not including commissions, if this trade works in your favor and the market moves above $15.40 by expiration. While the potential gain is limited with this trade, your risk is defined. Keep in mind, the CME announced plans to expand price limits in soybean futures on March 28 to 70 cents from 50 cents, so this market could become even more volatile, with even bigger ranges. So I think this strategy offers a more favorable risk/reward profile for a more conservative type of trader than a straight futures long position.
Corn
Corn futures have seen a similar pattern a soybeans. On Monday, March 10, May corn futures had traded down their limit as well, but recovered by day’s end, settling up 18 ½ cents at $5.65 ¾ a bushel. Corn futures continued to climb Tuesday, with May futures closing up 6 3/4 cents at $5.72 1/2.
Corn hasn’t seen as dramatic a decline as soybeans, and generally doesn’t move as fast in either direction as soybeans or wheat. Corn has sort of been the stepchild of the group. But as this market has also been volatile, I recommend a conservative strategy to take advantage of further upside potential. Ethanol is still a story that’s keeping prices up, and the battle for acreage between corn, soybeans and wheat will be interesting to follow given the moves we’ve seen.
I recommend buying July 590 corn calls for 46 cents, or $2,300 excluding commissions, and selling July 650 calls for 30 cents, for $1,500 excluding commissions. With this strategy, you collect premium on the sale, so your risk is defined at $800 (total cost), and your potential gain is $3,000 if the market moves above $6.50 by expiration, excluding commissions. These options expire June 20, 2008, and this strategy is a similar way to play upside as the one I mentioned in soybeans.
In general, I don’t see the big funds running for the door in either of these markets even if we see corrective moves. I’m looking for corn to rally to $7 and I think we’ll see it sooner rather than later, in early May. I feel this strategy offers a good risk-reward ratio.
I like wheat too, but it’s already had a big run, and I’m wondering if the top might be in or near for wheat. Australia’s crop is expected to improve and there are expectations of more wheat planted here in North America. There may be more upside, and a retest of the highs is possible, but I think corn and soybeans offer more room to move up. It’s an interesting time to trade commodities, and I think bull call spreads are a good way to capitalize on these trends.
Bob Haberkorn is a Senior Market Strategist at Lind Plus, Lind-Waldock’s broker-assisted division. He can be reached at 888-801-9302 or via email at bhaberkorn@lind-waldock.com.
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