Inverse in soybean futures

[Rob SC NE]

Interesting column by Roy Smith today, who points out that there is a rare inverse situation occuring in the soybean futures. November and January soybean futures are higher than the deferred May and July contracts. He points out we saw a similar situation in 2003-04, when we had a weather shortened crop then too.

"What we did not understand in 2004 was that the big inverse was telling us that prices would be higher when the supply of cash beans got used up," he says.

He saying that one idea now is sell cash beans and buy a call option. Selling beans now with futures at $15.60 and buying a July 14.80 call option eliminates the risk and cost of ownership and results in being exposed to price appreciation without the risk.

"If prices continue to rally as the spreads indicate they probably will, selling cash and owning the call option will be more profitable than owning the beans."

Anybody have any thoughts on this sorta deal?

Rob  

[GoredHusker]

We're inverted in soybeans primarily because the trade is trading a record crop coming out of SA.  They harvest in March making soybeans available to the world by May.  If we get this huge crop from SA, it's quite likely some of those beans will find their way into the U.S.  The price of beans is still a weather market as everyone turns their attention to SA.  If they get perfect weather, prices will drift lower.  If they don't, prices will go higher.  I don't disagree with the trade recommendation other than a July 1480 call is rather expensive to the tune of 90 cents a bushel. 

[sw363535]

Agreed, the "insurance premium" of a call seems pretty expensive. 

[Palouser]

In my region for SWW (PNW) I always take the view that an inverse signals the need for physical now and the 'volume play' in the face of declining supply. If they want product 'now' why would they signal to 'hold' or get into a later delivery contract? If there is plenty out there then why offer more 'now' or worry about a price offered later? 

An inverse has seldom offered the highest price of the season out here. I've even seen an inverse signaling me to hold, then in frustration the exporters all crashed the price by all going 'no offers' (funny how they can all do that within a few minutes) - and then they had to offer even higher prices in the end. I call it the 'lime-cottage cheese-marshmallow surprise'. Works for me.

[arnfarm735]

"Deja vu all over again," to quote Yogi Berra.

"Record acres and above trend line yeilds in South America."   Sound familiar. Like it is a done deal.

I agree about the cost of call options. That is always the road block for me -- high cost of the "insurance" premium. And when we are talking about July 13 contracts, that is a lot of time for price erosion. It is always the "in the money/out of the money" cost plus the time factor.

It is hard for me to see the big picture in purchasing calls when you spend $1.00 per bushel for a $14.60 strike price, so you are locking in an effective $13.60 price minus commissions and interest on your money. Looks like to me you need $1.00 increase in price just to get back to where we are today.

Help me out understanding the big picture and long range advantage to just taking the $14.60 cash price and moving on.

[Roy_Smith]

I put the comment about selling cash and buying a July call option or futures contract because selling cash and replacing it with paper has been promoted in the past as a way to reduce the risk without giving up ownership. The only way this has a possibility of working is when there is an inverse in the market approximately  equal to the cost of the call option. As one reader said, we are not quite there yet. Probably the best way to take advantage of the inverse and good basis is to sell and be satisfied with today's price. I did use the strategy on 2003 - 2004 and it worked very well. However the best part of it was that futures prices rallied into spring. As of today that is not happening! In 2003-2004 my first trades were made in the fall about this time but at a much lower price. Option premiums are very expensive and it takes a lot of number crunching to come up with a strategy that is better than making a cash sale and walking away. If you like testing out strategies this is a good market.There are a lot of possibilities, many of them not attractive when the real numbers are used.  Thanks for all of your comments.....Soyroy

[Jim Meade / Iowa City]

It seems to me that selling cash and buying paper keeps you in a speculative position, but now you have a floor.  Is the call price worth the insurance to have the floor?

If one wants/needs the money and is that comfortable that the price will go up, why not sell the cash and buy the board?  No call premium to have to earn back.  If one is suddenly not so sure that buying the board is the way to go, maybe that is a sign that buying a call is not the way to go, either.

Very interesting topic.

[GoredHusker]

Given this situation, I'd probably look at either buying a Jan 13' or March 13' put and holding onto the physical beans.  The cost of the option would be considerably less, and the floor considerably higher.  Plus, there should be basis improvement especially in a downtrending market.  If a weather scenario plays out in SA, one still has their physical beans to take advantage of a rallying market.  If a weather scenario doesn't play out, there should be significant basis improvement which may actually be enough to pay for the put. 

[Jim Meade / Iowa City]

I had to look up the score to see if you handle this week was "Go Red" or "gored".  Looks like it's "Go Red".  I knew it was a mistake to let Nebraska in to the Big Ten.  🙂

Anyway,  when you say you are going to buy a put, aren't you really saying you think the price of beans will go down?  Or do you see the put as an insurance premium.  If so, how do you value an insurance premium as opposed to a speculative cost?

At the end, I always get back to the quesiton of, "why would anyone write an option?"  Tha answer is always, "because they make money at it".  So, why buy and option?

[GoredHusker]

By selling the beans and buying the call, all ownership of the beans is gone.  Therefore, the seller gets absolutely nothing in terms of basis improvement.  By buying the put, yes one is putting a floor under their bushels all the while getting to take part in both basis improvement and futures price improvement.  The put is to protect against prices falling from a record SA crop.  IMO, it would be prudent to hold unsold soybean bushels until at least the first of the year but even better until March.  SA beans will not be available for shipment into the U.S. until probably at least April if not May.  I'd almost be willing to bet that basis appreciation between now and then will more than pay for the put regardless of whether prices move higher or lower on the futures. 

The ones writing options don't always make money.  If you don't believe me just ask Verasun.  They are bankrupt because of writing put options to pay the premium of the calls they bought.  Normally, I don't like options either.  However, we just endured a once or twice in a lifetime drought this past summer nationwide.  Sometimes it pays dividends to error on the side of caution.  If one is happy with the price of beans and doesn't really care whether or not prices get better because they can just start selling next year's, then by all means move out the cash and leave the options alone. 

With the way futures prices tend to move, a lot of agribusinesses have gotten away from the option writing business.  Cargill, Scoular, etc. once were big into premium offer type contracts where a producer might sell them 5000 bushels and offer an additional 5000 bushels for a large percentage of what the strike offered call was bringing.  They really don't push these contracts anymore because of the margin exposure it left them with.  Selling options isn't quite the slam dunk it was once upon a time.