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Marketing in a trade war

By Jon Scheve, Superior Feed Ingredients, LLC

Its official, the U.S. is now in a trade war. Last week some said a last minute negotiation could stop it, but that didn’t happen. It’s uncertain if this will last a few days, weeks, months or years. No one really knows the outcome to all of this and the market doesn’t know how to react as a result.

Good weather continues throughout the Midwest. At this rate record yields are a real possibility, meaning current prices are right in line. It’s now a waiting game through the balance of the summer to see how the weather turns out.

Beans have been looking for a bottom. Technically beans are due for a rally, but the rally on Friday could have been too quick and might be followed by a re-testing of the lows. Some say tariffs will drive Nov bean prices to $8, while others say the world needs our beans and, to get around the tariffs, will ship beans to other countries first then to China making $10 Nov futures realistic. Out-guessing the bean market this year will be impossible and probably only the lucky will be on the right side.

Market Action

New Trades #1 & # 2 – Sold calls

On 6/18/18 when Sep corn was near $3.65 I sold the following calls:

  • Sold an Aug $3.80 call for 9 cents – expires July 27thon 5% of my ’17 production
  • Sold a Sep $3.95 call for 9 cents – expires Aug 24thon 5% of my ’17 production
  • If corn is trading below the strike prices when these options expire – I keep the 9 cent premium and add it to another trade later.
  • If corn is trading above the strike prices when these options expire – I have to sell corn for the strike price PLUS I keep the premium. This means prices of $3.89 & $4.04 on Sep futures.

Trade thoughts and rationale

Since I still needed to sell some of my remaining ’17 corn but I don’t want to sell $3.65 Sep futures, these trades allow me to get values close to $4 if we rally some. If the market stays sideways, I keep the 9 cent premiums. There isn’t a downside protection with these trades but that wasn’t what I was trying to accomplish with the trades either.

New Trade #3 – Sold Straddle

On 6/13/18 when Sep corn was around $3.85, I sold an Aug $4 straddle (selling both a put and call) and bought a $3.70 Aug put, collecting 30 cents total on 10% of my 2017 production.

What Does This Mean?

  • If Sep corn is $4 on 7/27/18 I keep all of the 30 cents
  • Every penny corn is below $4 I get less premium until $3.70. With the $3.70 put I won’t lose anything on the trade, but I don’t have any grain protected to the downside or sold.
  • Every penny higher than $4.00 I get less premium until $4.30
  • $4.30 or higher – I have to make a corn sale at $4.00 against Sep futures, but I still get to keep the 30 cents, so it’s like selling $4.30

Trade Thoughts And Rationale

Back on 6/13/18 my rational was: This trade was most profitable in a sideways market. With the current good weather forecasts, I’d be happy collecting the premium to add to another opportunity later. However, if the market drops significantly I’m also protected from losing money or having to buy corn back with this trade. With what I know today, if the market rallies I’ll be very happy with a $4.30 sold price. I’m comfortable with any market outcome of this trade.

As of 7/6/18 my thoughts are: With where current prices are at I may not end up making any money on this trade. While mildly disappointing, I knew this was a possibility when I made the trade. I still have 20 days before this trade expires and if June taught me anything is that a lot can happen in a short time.

New Trade #4 – Sold Straddle

On 6/18/18 (5 days after trade #3) and after a 20 cent drop in corn with Sep futures around $3.65, I sold an Aug $3.70 straddle (sold both the put and the call) and collected 29 cents total on 10% of my production

What Does This Mean for this particular trade?

  • If Sep corn is at $3.70 at expiration on 7/27/18 I keep all of the 29 cents
  • Every penny corn is below $3.70, I get less premium until $3.41. At this point, I either have to buy back futures (i.e. remove a sale) or take a penny loss for every penny under $3.41 on the trade.
  • Every penny higher than $3.70 I get less premium until $3.99
  • $3.99 or higher – I have to sell my corn for $3.70 against Sep futures, but I still keep the 29 cents, so it’s like selling $3.99

Trade Thoughts And Rationale

Back on 6/18/18 my rational for the trade was: – Like Trade #3, this trade is most profitable in a sideways market. But unlike Trade #3, there are no puts in place to protect my downside. I think a 20-30 cent range is likely. Since I’m behind in my sales and I want the market to rally, I would be fine potentially losing a little on the upside potential. Regardless, this trade only represents 10% of my ’17 production, so I’m comfortable with any outcome.

7/6/18 Update on my thoughts of this trade – At this point with the unknown tariff issue and widespread perfect weather, I’m not sure the 29 cent range is going to be wide enough. Like Trade #3, while I’m always mildly disappointed when trades don’t work out like I think they will, I’m still comfortable with my decisions and all potential outcomes. Again with 20 days of trading left means I have time for things to change.

Offsetting Trades And The Importance Of Keeping Detailed Records

I always suggest that farmers keep detailed notes of each trade, including rationale and when different trades cancel out portions of other trades. In the above examples, since I bought $3.70 puts in trade #3 and sold $3.70 puts in trade #4 my hedge account will actually show that I have no $3.70 put position in place. Without detailed notes for each trade, a month from now when the trades expire, I may not remember all of the details and intentions of the trades.

In this example, the market changed dramatically in those 5 days, so my goals and strategy needed to shift as well. While each trade is independent of each other, and on the surface may seem to conflict with each other, they really don’t. Both trades ladder up to a larger overall marketing strategy and philosophy.

Why It’s Important For Me To Have A Marketing Philosophy

Given the uncertainty of the market year after year and the widespread variances of analyst information on the markets, it’s easy for farmers to think they need to change their marketing strategies every year to keep up. Or worse, analysis paralysis sets in, and farmers do nothing, unsure what the correction decision is.

That’s why it’s important for me to have a marketing philosophy, which lays out the my guiding principles when developing my marketing strategies and trades. By adhering to these principals and guidelines continually I can make better decisions for my farm operation. Following provides the foundation for my marketing philosophy.

Sell an Average Size Crop at an Average Price That Would be at a Profitable Level

This may sound obvious, but after a 12+ month sideways market at unprofitable prices, it’s easy to consider selling under breakeven levels. Still the important words here are “AVERAGE”. Every trade I do doesn’t have to be profitable, but in the end, my final position must show a profitable price point every year. This is much more difficult in practice.

Be Ready To Take Advantage Of Opportunities

While the market can run below breakeven prices for while, it will eventually rally to profitable levels. When that happens I need to be ready to take advantage, because the market can fall just as quickly and easily. At the same time I also worry about prices rallying to an extremely high level too. I like to leave a little upside potential just in case something totally unexpected comes along as well.

Limit My Risk Exposure

I understand the difference between speculating (i.e. gambling) and hedging. And while there will always be uncertainty in the markets, I limit my exposure to risk by avoiding trades that “bet” big on one certain market direction.

Understand And Be Willing To Accept Every Possible Market Outcome For Each Trade Placed

At any time there is a chance the market could go up, down or sideways. Therefore, for each trade I place I understand what my final outcome is for each scenario. I then need to be comfortable with any outcome. If I’m not, I don’t place the trade. Period.

Understand That No One Can Predict The Market

While I try to do trades that are most profitable given the most likely marketplace scenario happening, no one knows what is really going to happen. There are just too many variables driving the market, that it’s impossible. The only thing I know for sure about the market is that it will continue to surprise me.

I Won’t Always Be Right

I wish I always sold at the right time. And while I think I do well making decisions generally, sometimes a trade doesn’t go as planned. When that happens, I review the details of the trade, learn from it, and move on. It’s also important to look at how the market reacts as an exception or the rule. 2012 will always be that exception year. The way the market has behaved from 2013 until now seems to be more along the line of the rules. It also seems that every year will have its own little exception as well. It seems like we might be in one of those right now.

All too often farmers want to “hit the home run” by selling all of their grain at the market high. While selling at profitable prices is important, waiting too long to sell may mean a “strike out.” It’s just not realistic that a farmer will always sell everything at the top, so that shouldn’t be the goal. Instead, I remind myself that even if I sell and prices keep going up, I still have more grain to sell (i.e. next year’s crop). So, I can take advantage of upcoming rallies, it just may be for future grain.

Play The Odds

While the market can go up, down or sideways at any time, there are factors that can often increase the likelihood of one of the scenarios. And while every farmer wants prices to rally, market conditions may suggest a rally isn’t the most likely outcome. Sometimes sideways markets are the most likely, so placing trades that maximize opportunities when this happens can be a good decision.

Be Open And Consider Alternative Solutions

Being open to considering alternative solutions that allow for increased profits during an unprofitable market can help too. If the market suggests a long-term sideways market is ahead then doing trades on a portion of the crop, like selling calls or straddles as mentioned above, can help with being profitable when the market isn’t moving.

There are a lot of marketing philosophies out there, and what works for me, may not work for someone else. Some farmers don’t have the same values and goals as I do, and that’s ok. The important thing is to find a marketing philosophy that works for you and your personality and goals, and then use it to set a foundation to make all of your marketing decisions.

Jon grew up raising corn and soybeans on a farm near Beatrice, NE. Upon graduation from The University of Nebraska in Lincoln, he became a grain merchandiser and has been trading corn, soybeans and other grains for the last 18 years, building relationships with end-users in the process. After successfully marketing his father’s grain and getting his MBA, 10 years ago he started helping farmer clients market their grain based upon his principals of farmer education, reducing risk, understanding storage potential and using basis strategy to maximize individual farm operation profits. A big believer in farmer education of futures trading, Jon writes a weekly commentary to farmers interested in learning more and growing their farm operations.

Trading of futures, options, swaps and other derivatives is risky and is not suitable for all persons. All of these investment products are leveraged, and you can lose more than your initial deposit. Each investment product is offered only to and from jurisdictions where solicitation and sale are lawful, and in accordance with applicable laws and regulations in such jurisdiction. The information provided here should not be relied upon as a substitute for independent research before making your investment decisions. Superior Feed Ingredients, LLC is merely providing this information for your general information and the information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision. The contents of this communication and any attachments are for informational purposes only and under no circumstances should they be construed as an offer to buy or sell, or a solicitation to buy or sell any future, option, swap or other derivative. The sources for the information and any opinions in this communication are believed to be reliable, but Superior Feed Ingredients, LLC does not warrant or guarantee the accuracy of such information or opinions. Superior Feed Ingredients, LLC and its principals and employees may take positions different from any positions described in this communication. Past results are not necessarily indicative of future results. He can be contacted at jon@superiorfeed.com.

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