Monday, July 16, 2012

Trading Options in CORN

I am firmly of the Jim Cramer school of thinking that believes, “There is always a bull market somewhere.” Of course, with the advent of inverse exchange-traded products ETPs), you can turn just about any bear market upside down and transform it into a bull market...

With stocks stuck in a sideways drift for the last two months, the one corner of the financial markets that has been red hot has been corn. Since the beginning of June, corn futures are up more than 40%, rising from $5.51 per bushel to $7.73 per bushel. While institutional investors have been actively bidding up corn futures, most retail investors are likely to prefer the ETP route, where the Teucrium Commodity Trust Corn Fund ETF (CORN) is the only pure play on corn.

Back on July 5th, with corn at $7.19 per bushel, I talked about the potential for corn to go parabolic when I observed:

“Extreme price moves are not uncommon, particularly when unusual weather patterns are involved…Note that while the June-July 2012 move in corn looks impressive, it pales in comparison to the spikes in corn prices that occurred in 1994-1996, 2005-2008 and 2010-2011. In other words, this could be just the beginning of a huge move in corn prices, particularly given that the price move of the last month or so comes on top of a much higher base.

Corn may be putting in a top soon, but a fat-tailed spike is not guaranteed to top out at the prior highs of $8.00 per bushel.”

Whether you are long or short – or have no position in CORN (or corn futures) – the current environment looks like an excellent time to think about CORN options. Traders who are long CORN are likely sitting on substantial gains and while some maybe be tempted to take some profits, the possibility of a breakout above $7.73 per bushel is just too attractive to part with that position. For this reason, longs may wish to consider the commodity/ETP version of a stock replacement strategy. Here the idea is to sell the CORN ETF, pocket the profits, and use a portion of those profits to buy some out-of-the-money CORN calls. With the CORN ETF closing at 49.85 today, the August 50s, 55s or even 60s might be a reasonable target. Should CORN reverse direction, a portion of the initial profits will be retained, but if there is another big bull leg, this options trade could turn a solid winner into the trade of the year.

Shorts might consider a similar limited risk approach. Rather than run the risk of continuing to be squeezed by a speculative buying frenzy, one strategy that makes sense is to close out any short CORN (or corn futures) position and buy some out-of-the-money puts. The August 45s and 46s are a popular choice, but there are some other excellent alternatives.

Finally, perhaps you have no desire to make a directional trade in corn and believe all the hype overstates the reality and prices are likely to remain a lot closer to their current level than spike again or plummet. Here a short strangles or straddles are sensible approaches, as are their limited risk counterparts, condors and butterflies.

If any of this sounds familiar, readers may recall that I made the argument for a similar strategic approach with silver at the height of the silver frenzy on April 27, 2011 in Is Volatility a Better Play for Silver Than Direction? With the benefit of hindsight, that post was published just two days after what turned out to be the intraday top in silver and two days before silver’s all-time closing high. I’m not saying the top in corn is here right now, but every day we get a little closer to that top and some of the options trades get a little less attractive.

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Disclosure(s): neutral position in CORN (via options) at time of writing

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