×
×
homepage logo

BRIAN HOOPS

By Staff | Feb 12, 2010

The vast majority of our clients are interested in options and low-risk option strategies. Here is one strategy that is not used often enough – free trade, or the zero risk trade.

For example, let’s assume you want to purchase a soybean call option because you have a bullish outlook for this market. You want to limit your risk in the trade so you elect to buy a 1,000 July call option for 40 cents. Now you have a bullish position with risk limited to the 40 cents you paid for the option. Let’s assume you were correct and soybeans rally to $10.60 and your call is now in the money. You can now sell a 1,100 July out of the money call for 40 cents and your account is credited with the 40 cents, offsetting the 40 cents you paid for the long call option you purchased.

From this point on, you have zero risk on your initial investment and still have profit potential up to the 1,100 strike price out of the money call. Your breakeven point is now locked in, as long as soybeans close above the 1,000 strike price, you will make money on the trade, with your worst case scenario of losing zero.

Here is another example by using put options. Let’s assume you have a bearish outlook for lean hogs, thus, you purchase a June 70 put option for $2. Now you have a bearish position with risk limited to the $2 you paid for the option.

Let’s now assume you are correct and lean hogs trade lower and your put option is now in the money. You can now sell a 60 put option for the same $2 you paid for the put and your account is credited with the $2.

From this point forward, you have zero risk on your initial investment and still have profit potential to the 60 strike of the out of the money put option you sold. Your breakeven point is now locked in, and as long as lean hogs close below the 70 strike price, you will make money on the trade, with the worst case scenario of breaking even.

The free trade is a great way to take the emotions out of trading and that can help you stay the course in the trade until your profit objective is met. Free trades can be made as conservative or as risky as you choose.

For example, you can sell options different strikes out of the money, depending upon how much profit and how much risk you are willing to assume or you can sell multiple options to offset your option purchase.

Corn analysis

Corn closed the week $.05 lower. With the drop in prices, export business is starting to pick up, including the USDA reporting a 116,000 metric tons corn sale to an unknown destination. Commercials continue to provide support to the market as they are buying back their shorts and are now using price weakness as an opportunity to extend coverage into the summer months, which always brings uncertainty and production concerns.

As the prices work lower during the winter months, producers should look to use options as a way to re-own cash sales for a summer rally. If prices fall to weekly support of $3.10, look for major commercial buying to support the market at this area and should establish a winter low.

The weekly export sales report showed net sales of 923,200 MT for delivery in 2009/10 were up 2 percent from the previous week and 15 percent from the prior four-week average. Increases were reported for Mexico (376,800 MT), Japan (234,700 MT, including 109,500 MT switched from unknown destinations and decreases of 42,300 MT), unknown destinations (89,700 MT) and Taiwan (69,300 MT). This year’s export profile is now at 1.147 billion bushels versus 953 million bushels a year ago.

Strategy and outlook: Producers should have hedges up to the 70 percent level. Producers will want to use price weakness to re-own cash sales with futures and options on a price correction. Buy July options on a pullback into a support level. Hedgers have sold a portion of the 2010 crop when December futures traded above $4.50. When prices move above last spring’s highs of $4.73, producers should look at buying new crop put option protection and add to cash sales.

Soybean analysis

Soybeans closed the week a 1/2 cent lower. Prices slid lower but uncovered major commercial support that limited the downside for the soybean market. Growing conditions in South America remain nearly ideal as it has been warm with timely rain showers. Soybeans continue to be on pace to test key support at $8.92 before finding seasonal lows. The commercials are now holding a net long position while the sentiment index is at a bullish reading.

The weekly export sales report showed net sales of 381,500 MT for delivery in 2009/10 – a marketing-year low – were down 43 percent from the previous week and 51 percent from the prior four-week average.

Increases were primarily for China (262,500 MT, including 166,000 MT switched from unknown destinations and decreases of 39,700 MT), Indonesia (89,400 MT, including 65,000 MT switched from unknown destinations. This year’s export profile remains well ahead of last year’s record pace, 1284 mb versus 905 mb.

Commercials are at their most bullish position since the rally began in March 2009. Look for major commercial support to limit the downside in soybeans to the $8.92 chart support.

Strategy and outlook: Producers should have hedges at the 70 percent level. With the tight basis levels and lack of carry in the market, the market is telling producers to sell the product now and use price weakness to re-own the crop with futures and options. Buy July options on a pullback into a support level. Producers have sold 2010 crop when November futures traded above $10.30.

Brian Hoops is president and senior market analyst of Midwest Market Solutions Inc. Midwest Market Solutions is a full-service commodity brokerage and marketing advisory service, clearing through R.J. O’Brien.

Please Enter Your Facebook App ID. Required for FB Comments. Click here for FB Comments Settings page