commercial/end user hedge strategy - cme group · corn strategy 1 •allows the hedger to be fully...
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© 2015 CME Group. All rights reserved.
Commercial/End User Hedge Strategy
David Hightower/CME Group
March 25, 2015
© 2015 CME Group. All rights reserved.
Short-Dated New Crop Options
• OI is currently around 100,000 in the SDNC complex
• Feb ADV = 4,163, 48% more than a year ago
• OI peaked at 213,053 last year (2014).
0
50,000
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150,000
200,000
250,000
300,000
SHORT DATED NEW CROP CORN OPTIONS SHORT DATED NEW CROP SOYBEAN OPTIONS
© 2015 CME Group. All rights reserved. 3
Weekly Options
• 2015 YTD ADV =2,356. Corn is the most active, accounts for 67%, Soybean 29%
• Used to hedge short term events such as USDA crop reports and weather forecasts during
growing season.
• Reduce hedging costs due to low time value, thus low premium.
Commercial/End User Hedge Strategy
David Hightower/CME Group
March 25th, 2015
56.40
86.25
87.75
50
55
60
65
70
75
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90
95
1001
99
0
19
91
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92
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93
199
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Est
Mill
ion
Acr
eas
US Grains Planted Acreage with Prospective Plantings Esimates
Wheat Wheat Est.
Soybeans Soybean Est
Corn Corn Est
Classic Blow-Off Top?
Fundamental Confirmation Story?
-200,000
-150,000
-100,000
-50,000
0
50,000
100,000
150,000
200,000
250,000
300,000
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Soybeans - COT - Futures and OptionsNon-Commercial and Nonreportable Combined Net Position - Number Of Contracts
The Hightower Report | Source: CFTC | Max: 256,534 (7/17/2012) - Min: -166,905 (9/23/2014) - Most Recent: -92,722 (03/17/2015)
Some of the Bearish Case is Factored
-280,000
-210,000
-140,000
-70,000
0
70,000
140,000
210,000
280,000
350,000
420,000
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Corn - COT - Futures and OptionsNon-Commercial and Nonreportable Combined Net Position - Number Of Contracts
The Hightower Report | Source: CFTC | Max: 366,547 (10/12/2010) - Min: -255,612 (10/29/2013) - Most Recent: -89,572 (03/17/2015)
Short-Term Acreage Factors
• With little difference in expected returns, producers (outside
of central Midwest) likely to shift to beans and less corn as
costs are much smaller.
• Mississippi corn planting 0% vs 5-yr avg of 16%. Louisiana
1% vs. 5-yr avg 48%. Georgia 0% vs 5-yr avg 19%.
• More sorghum & spring wheat/less corn & soy by default.
• Last year, Outlook Forum pegged soybean plantings at 79.5
million acres vs. actual 83.7 (+4.2).
• When looking at 8 major crops and 1.3 million less CRP
acres, the USDA sees plantings down 4.7 million acres from
last year?
Soybeans Bearish/Opportunity
USDA SUPPLY/DEMAND 2015/16 Acreage Variations
US SOYBEANS Mar Mar Mar 2015 USDA Farm
USDA USDA USDA Outlook Hightower Futures
08-09 09-10 10-11 11-12 12-13 13-14 14-15 Forum Estimate Estimates
Planted Area (M Acres) 75.7 77.5 77.4 75.0 77.2 76.8 83.7 83.5 86.3 87.3
Harvested Area (Acres) 74.7 76.4 76.6 73.8 76.1 76.3 83.1 82.7 85.4 86.4
Yield (Bu/Acre) 39.7 44.0 43.5 41.9 40.0 44.0 47.8 46.0 46.0 46.0
Beginning Stocks (M Bu) 205 138 151 215 169 141 92 385 385 385
Production 2,967 3,359 3,329 3,094 3,042 3,358 3,969 3,803 3,928 3,973
Imports 13 15 14 16 41 72 25 20 20 20
Supply,Total 3,185 3,512 3,494 3,325 3,252 3,570 4,086 4,208 4,333 4,378
Crushings 1,662 1,752 1,648 1,703 1,689 1,734 1,795 1,840 1,840 1,840
Exports 1,279 1,499 1,505 1,365 1,317 1,647 1,790 1,820 1,820 1,820
Seed 90 90 87 90 89 97 92 92 92 92
Residual 16 20 43 -2 16 0 24 26 22 22
Use, Total 3,047 3,361 3,279 3,155 3,111 3,478 3,701 3,778 3,774 3,774
Ending Stocks 138 151 215 169 141 92 385 430 559 604
Stocks/Use Ratio 4.5% 4.5% 6.6% 5.4% 4.5% 2.6% 10.4% 11.4% 14.8% 16.0%
32
9.0
4
27
8.4
4
29
2.3
0
20
9.1
1
33
4.8
1
18
3.4
6
13
1.8
4
19
9.8
1
34
8.4
8
29
0.1
6
24
7.7
6
20
8.0
8
17
8.3
2
11
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0
25
5.7
4
44
9.3
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57
3.8
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92
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7009
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Est
Mill
ion
Bu
shel
s
US Soybean Ending Stocks
2015: If 85M Acres and 46 Yield Means a 502 Ending Stocks
0.0%
4.5%
9.0%
13.5%
18.0%
22.5%
27.0%
31.5%
36.0%
40.5%
45.0%
0
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10
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35
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45
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Pe
rcen
t of W
orld
Expo
rtsM
illio
n M
etri
c To
nn
es
Brazil Soybean Exports vs. Brazil Exports as Percent of World Exports
Brazil Exports Percent of World
Soybean Outlook • US stocks threatening record high. World stocks already
at a record and 27% above previous reading.
• Trade may be underestimating Brazilian export impact on world values once demand is saturated.
• July Soybeans have downside targets of 938 and then 873. Resistance 997, 1016.
• July to trade 14 cents UNDER Nov, vs. 23 cents over.
• Sell bean calls to buy corn calls/sell corn puts to buy bean puts
• Use cheapest long hedge possible, especially one that doesn’t get in the way of opportunity.
Key Short-Term Negatives for Corn
• Bearish soybean trend, bigger meal supply.
• Potential that the surging $ will weaken demand for US corn.
• Crude oil bears selling corn; ethanol margins?
• December 1st US corn stocks were at record high, so spring thaw could spark aggressive producer selling.
• World stocks at a 15-year high.
• China corn feed demand is still expanding but still not buying US corn.
• Active US ethanol exports late last year, but currency moves had US importing a cargo of Brazilian ethanol last week!
USDA SUPPLY/DEMAND 2015/16 Yield Variations
US CORN Mar Mar Mar 2015 USDA M inus
USDA USDA USDA Outlook Hightower 2 M il Acres &
08-09 09-10 10-11 11-12 12-13 13-14 14-15 Forum Estimate Lower Yield
Planted Area (M Acres) 86.0 86.4 88.2 91.9 97.3 95.4 90.6 89.0 87.8 87.0
Harvested Area (Acres) 78.6 79.5 81.4 84.0 87.4 87.5 83.1 81.6 80.5 79.8
Yield (Bu/Acre) 153.9 164.7 152.8 147.2 123.1 158.1 171.0 166.8 164.0 162.0
Beginning Stocks (M Bu) 1,624 1,673 1,708 1,128 989 821 1,232 1,777 1,777 1,777
Production 12,092 13,092 12,447 12,360 10,755 13,829 14,216 13,616 13,200 12,927
Imports 14 8 28 29 160 125 25 4 25 25
Supply, Total 13,729 14,774 14,182 13,517 11,904 14,686 15,472 15,397 15,002 14,729
Feed & Residual 5,182 5,126 4,798 4,566 4,315 5,036 5,300 5,275 5,275 5,275
Food, Seed & Industry 5,025 5,961 6,425 6,421 6,038 6,501 6,595 6,635 6,635 6,635
Ethanol for Fuel 3,709 4,591 5,019 5,000 4,641 5,134 5,200 5,225 5,225 5,225
Domestic Total 10,207 11,087 11,224 10,987 10,353 11,537 11,895 11,910 11,910 11,910
Total Exports 1,849 1,979 1,831 1,541 730 1,917 1,800 1,850 1,850 1,850
Use, Total 12,056 13,066 13,055 12,528 11,083 13,454 13,695 13,760 13,760 13,760
Ending Stocks 1,673 1,708 1,128 989 821 1,232 1,777 1,637 1,242 969
Stocks/Use Ratio 13.9% 13.1% 8.6% 7.9% 7.4% 9.2% 13.0% 11.9% 9.0% 7.0%
Corn - Will Downside be Limited Early?
13.39%
7.41%
0%
3%
6%
9%
12%
15%
18%
21%
24%
27%
19
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Est
Crop Year Beginning
US Corn Ending Stocks/Usage Ratio
Lower Acres & Yield USDA
If 87 Planted, 162 Yield and 5% China ‘Nick’
0.0%
5.5%
11.0%
16.5%
22.0%
27.5%
33.0%
38.5%
44.0%
49.5%
0
25
50
75
100
125
150
175
200
225
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End
ing Sto
cks / Usage R
atioM
illio
n M
etri
c To
nn
es
World Corn Ending Stocks vs. Ending Stocks / Usage Ratio
Ending Stocks Ending Stocks / Usage Ratio
2015 - Hightower Estimate
Corn Outlook
• Brazil, Argentina, South Africa and Ukraine crops all
look smaller ahead.
• China feed grain demand still surging ahead.
• Minor acreage shift plus any below trend yield this
year to tighten US and world supply.
• Key support for Dec corn is 393 – If fail, 378-364
support zone.
• If minor weather glitch – 450 to 456 resistance.
• If actual weather issue – 557 is 1st upside target!
Strategy over Opinion
• Opinion influences personality of the hedge.
• Market factors/opinion influence writing/buying.
• Opinion manifested in leverage or no leverage.
• Recent conditions influence.
• Market expectation influences.
• Historic comparisons.
Factors to Consider in Constructing Hedges
• Large soybean ending stocks increase the
possibility of a big price decline.
• Acreage allocation between soybeans and
corn is critical this year.
• Soybean large & small spec position is
now net short 92K versus net short 167K
at harvest, so it is less oversold.
• Compacted/delayed soybean flow from
Brazil due to truckers strike.
• Corn volatility is relatively low, perhaps
because of narrower range of expectations
for ending stocks.
• A loss of corn acreage would leave the
balance sheet tight & reduces downside
• The narrowest annual range for Nov Beans
since 2006 is $1.33 (Jan to exp). The range
so far this year is 92 ½ cents.
• The narrowest annual range for Nov
Beans since 2006 is $1.33 (Jan to exp)
The range so far this year is 92 ½ cents.
• The narrowest annual range for Dec
Corn since 2006 is $1.10 (Jan to exp).
The range this year is only 39 ½ cents.
• There could be a divergence between
corn and soybean prices due to the large
supply potential for soya.
• There appears to be less upside risk for
soybeans than in corn.
• Falling oil prices & the strengthening $
initially limits upside price.
• Dry and warm early planting conditions
could increase corn acres.
Corn Strategy 1
• Allows the hedger to be fully priced ahead of the upcoming reports.
• Protection against possible bearish report news.
• If a sharp break continues into early April, one or both of the puts could be lifted prior to April 24th expiration to lower the base hedge price.
BUY 1 Dec Corn futures contract and BUY 2 May Corn short dated new
crop (SDNC) just out of the money puts for around 8 cents each.
Corn Strategy 1
Source: QuikStrike - Options Pricing and Analysis Tools
Corn Strategy 2
• Owning week 2 on the money call spread provides close-in price sensitivity for low cost.
• Hedge is limited because the strike price for the short call position is only 25 cents higher than the long call.
• Selling the out of the money put further reduces the cost and leaves budgetary room for future risk coverage beyond this relatively short time frame.
• Limiting outlays into the first key pivot point of 2015 might allow for fresh hedges at lower prices.
Less Aggressive Strategy
With May Corn trading near $3.85, BUY 1 April Corn week 2 $3.85/$4.10
bull call spread for net premium of about 7 1/2 cents, and then SELL 1
April Corn week 2 $3.80 put for about 6 1/2 cents.
Corn Strategy 2
Source: QuikStrike - Options Pricing and Analysis Tools
Corn Strategy 3
• Long term protection with a chance to finance a portion of the hedge costs.
• The May SDNC calls have only 30 days until expiration – could see a significant loss in value if prices decline or market trades sideways.
• The long December Corn call position is the “hedge,” while the short dated new crop call is a financing vehicle or a “hedge of the hedge.”
• If the market continues to trend lower into the April 24th expiration, the hedger will have reduced the cost of owning the $4.40 call to just 11 cents.
• December calls do not expire until November 20th.
With December Corn trading near $4.09, BUY a December Corn $4.40
call for around 23 cents and SELL 1 May Corn SDNC $4.10 call for
around 12 cents.
Corn Strategy 4
• The net cost only 3 cents.
• Attempting to collect call premium from a market that appears to have
a potential to build significant supply and invest that premium in a
market that could easily become tighter.
• If soybean acres increase sharply, corn acres will likely decline, which
could lead to a dramatic tightening of corn stocks and higher corn
prices.
Macro Hedge-Using Soybeans as a Shield against Higher Corn
Prices
With November Soybeans trading near $9.57 and December Corn near
$4.09, SELL a June Soybean SDNC $9.60 call for around 28 cents and
BUY 2 June Corn SDNC $4.10 calls for a combined cost of around 31
cents.
Soybean Strategy 1
• Potential for huge ending stocks, heavy flow of South American soybeans onto the global market and an expected adjustment higher in 2015 soybean plantings should increase the chance prices decline in the near future.
• Commercials and end users may want to postpone their prompt and forward purchases.
• Coverage against a bullish surprise for very little cost.
• Main drawback – short duration.
Minimal Hedge, Moderately Bearish Price View
BUY 1 Week 2 April Soybean at the money call for around 20 cents
(16 days coverage).
Soybean Strategy 1
Source: QuikStrike - Options Pricing and Analysis Tools
Soybean Strategy 2
• Expectations for heavier planting acreage, increased South American export competition and knock-on from deflationary view increases the odds of lower cash prices ahead.
• Expend minimal hedge call premium and secure some upside protection beyond the March 31st report and into the early planting window.
Slightly More Aggressive, Increased Sensitivity & More Time
BUY 1 May Soybean SDNC at the money call for around 20 cents
(30 days coverage).
Soybean Strategy 2
Source: QuikStrike - Options Pricing and Analysis Tools
Soybean Strategy 3
• Financing longer term calls with an aggressive short-term bearish play using short calls.
• If futures rally 50 cents in the coming month, the short SDNC calls will show a loss of roughly 15-17 cents, depending on time decay and volatility. On a 50-cent rally, the 2 November calls should appreciate roughly 40 cents.
• Moderate hedge coverage with reduced out of pocket expense and the chance to collect some premium using from the short-dated calls.
• To further reduce the cost of the hedge, traders could consider selling the April Soybean week 2 $9.40 puts for 7 1/2 cents, as soybeans are already down from the March highs and are somewhat oversold.
More Aggressive Strategy - Attempt to Finance Forward Hedge Cost with
Decay and Flat Price Weakness
With Nov Soybean futures trading near $9.57, SELL 1 June Soybean SDNC $9.40 call for
38 cents (56 days coverage), and then BUY 2 November Soybean $10.40 calls for 32
cents each or 64 cents total (212 days coverage).
Net premium paid 26 cents.
Soybean Strategy 4
• Initial delta long about 40% of 1 futures contract.
• Performs best if the market is weak in the next 30 days.
• As long as the short call remains in place, will remain sensitive into the middle of May. After that, the short call component will reduce performance and increase risk.
• If a surprise extended rally, hedge position could extend its sensitivity to the equivalent of almost 2 full futures contracts.
• Low net out of pocket expense – does not perform well on a minor rally that comes to a halt but will reap windfalls if prices rally straight-away.
SDNC Soybean Hedge/Ratio Back Spread
With Nov Soybeans trading near $9.57, SELL 1 July Soybean SDNC $9.40 call
for around 47 cents and BUY 3 July Soybean SDNC $10.00 calls for around 63
cents total.
