CFGAG News and Views           vol. 18    January 1, 2011
 
"There is a risk of loss when trading futures and options. The thoughts and opionions in this article are those of the author, and while believed to be correct, are not guaranteed as to the accuracy or content. Past performance is not indicative of future results, and each individual should examine their own risk capital carefully before trading."
 
Happy New Year!
 
We end 2010 on a very high note, as market prices for grain have put in new highs this week, and market sentiment reamains very bullish. 2011 should be a very profitable year for grain producers, as long as we have a plan to take advantage of these prices. We have recieved many questions this past month of December as the markets rallied on, and we feel like these form the base of a good newsletter, as they come from producers. These include:
 
1) How high can this market go?
2) What are the risk factors that could cause markets to sell off?
3) Why are options so expensive?
4) Is there a cheaper way to put in a price floor and still leave the upside open?
5) What are the critical times to watch for major market moves?
 
We start with the last one, as we approach one of the biggest USDA report days of the year, January 12. At 7:30 central time, we will get the final production report from the 2010 crop, as well as the Quarterly Grain Stocks report, which will set the table for traders to work with until the next major report on March 31, the Prospective Plantings. The trade is currently looking for bullish numbers, based on soybean exports, Argentine weather problems, strong demand for corn reflected in record ethanol production, and concern over possible reductions in quality and production in Austrailia. These items are well known to the trade, and one concern is that there may be a lot of these concerns already reflected in current prices. We all remember last January, when it seemed everyone was bullish, looking for cuts in yield to lower corn ending stocks, and USDA actually raised the crop 200 million bushels, which sent corn prices down sharply, and kept markets on the defensive until the onset of the drought in Russia this past summer. Are we setting ourselves up for something similar, or will this be the report that forces rationing like we have not seen before?
 
Which leads to #1 above: how high can we go? We can go as high as someone will pay, period. It is easy to reference 2007-2008, we we got within a whisker of $8.00 corn. It is always possible, and one should never say never, when it comes to market actions. We all remember what happened after that lofty peak was made, folks told us we had reached a new plateau, corn would never be under $6.00 again, and so on. Funny, but it didnt take long, a few months, as we traded below $3.00 in corn. Could it happen agian? Sure. While the odds seem strongly stacked against such a move, we always have to look at the other side, no matter how high bullish consensus is. Risk factors include:
 
1) Speculative money outflows into other markets
2) Weather improvements in Argentina
3) Economic meltdowns in Europe
4) Chinese government actions on speculation, hording, and food inflation
5) Demand destruction from high prices: livestock liquidation, ethaol plant shutdowns,
6) January 12 report surprises
 
So what do we do? We always advise to assess risk at the critical times of the year, and make non-emotional decisions as to possibly laying off some of that risk. January 12 is the next big one to deal with, and we think the possible outcomes do justify at least looking at ways to cover ourselves. Option plays with puts worked very well last year, but are very expensive at first glance this year. At the money February corn puts are over 25 cents, and expire January 21st, providing only 3 weeks of coverage if bought immediately. If this seems very high, just look back on the December 10 corn chart and count the moves both ways of nearly a dollar per bushel. Sometimes the market moved 50 cents in less than 2 weeks, and in one instance, 50 cents in three days. With more risk comes more cost of laying off that risk, and thats why options seem very expensive, but in relative terms to the price of the commodity, aren't so bad. As one wise old veteran of the markets told me, "If you think these options are too pricey, you can always sell them". To us, it comes down to how much risk you want to accept, and how much you want someone else to carry. There are no magic formulas to guarantee anything in thesse markets, only a cost and risk analysis based on your wants and needs. That is what we try to do when working with you.
 
As far as strategies, there are lots to choose from, based on everything discussed above. Puts and put spreads to cover the downside, with sell stops in the futures to protect minimum price goals are some to choose from. For instance, lets say I want to guarantee at least 5.00 new crop corn. For approximately 30 cents premium cost, I can buy a 5.50 December put, and sell a $5.00 December put, and place a sell stop at $5.00 December futures. Depending on the February average price of December futures, I can reduce risk further through crop insurance purchases, and change my option postions accordingly, but at least have some floor in place in case one or more of the risk factors mentioned come to pass. As always, remember these are prices gathered at the time of writing this article, and can change a lot in minutes, so call us if you have questions or ideas to chew through. We also like to look at options in terms of time value, and only buy "what we need" in terms of that time, but everyone is different, and sometimes managing the position becomes more stress than the time value is worth, and thats why we respect the individual's wants and needs first.

From  the technical side, we have the following numbers from our computer to consider: