How to Make Money from Grain Fundamentals
Knowing what is really moving grain prices can give you a leg up as an Option Seller
As so few traders and investors actually know the behind the scenes supply and demand forces that are actually moving the prices reflected on their charts, knowing them can give you a decided advantage in commodities and in particular, as an option seller.
The fundamentals won’t necessarily tell you where price is going to go. But they will tell you when conditions are right for a move this way or that way. And they can often be a great tip off to where prices will not go. In other words, if the sky is clear and bright, odds are you aren’t going to get hit with a storm in the next 10 minutes. That’s exactly the kind of bet option sellers make. Yet, you’d be surprised how many traders never bother to go outside and look up at the sky.
There are two key figures that can give a “snapshot” of the fundamental situation in any grain market.
For many, it’s a matter of not knowing where the sky is or how to interpret what they see.
In this Option Seller Institute segment, we’ll give you the key fundamentals to watch in the grain market and give you some quick “rules of thumb” to let you know if you’re selling premium in a clear sky market, or if conditions are clouding up.
Grain Fundamentals – The Basics
While it would be impossible to cover all of the fundamentals that go into price discovery in the grain markets in one column, we’re going to present two key figures here that you can watch that will give you a “snapshot” of the current fundamental situation of any grain market.
These figures are so important because every factor that affects supply and demand gets factored into them.
For grain markets, we’re talking about corn, wheat, oats and also soybeans and soybean products (such as soymeal and soyoil). While soybeans aren’t technically a grain, we include them in grain discussions because they share the same characteristics as grains in fundamentals.
The 2 Key figures you Need to Know
For price discovery in grains, there are two key figures you need to know.
Ending Stocks: The amount of grain left in storage at the end of the “crop year” (September 1) after all demand has been met. Ending stocks can also be more informally referred to as “leftover” or “carry over” stocks.
Stocks to Usage Ratio: The amount of the projected demand for the upcoming year divided by projected Ending Stocks. In other words, if there was no crop at all this year, stocks to usage ratio would tell you what percentage of demand could be met by using up what is leftover from last year’s crop.
Lets talk a little about each.
For instance, On July 10, the USDA gives its crop report and gave an estimate for 2015/16 US Corn Ending Stocks. This is where they expect US corn supplies to next September 1, 2016 (just prior to next year’s harvest). This latest report (below) indicates the USDA expects 2015/16 corn ending stocks to be 1.599 billion bushels.
Ending Stocks are an important guage of the overall supply picture
Ending stocks take all of the year’s supply, subtract all of the year’s demand, and come up with a figure. Ending stocks are actually mere projections of where supply will be and are adjusted monthly until the definitive number is realized on September 1. In fact, they will often still be adjusted for months afterward (as the final numbers roll in).
Example: USDA Supply Demand Report for Corn
|USDA SUPPLY/DEMAND US CORN|
|Area (M Acres)|
|Beginning Stocks (M BU)||821||1,232||1,876||1,779|
|Feed & Residual||5,034||5,300||5,300||5,275|
|Food, Seed & Industry||6,503||6,546||6,560||6,585|
|Ethanol for Fuel||5,134||5,200||5,200||5,225|
|Ending Stocks (mb)||1,232||1,779||1,771||1,599|
The monthly USDA Supply/Demand report shows ending stocks and stocks to usage for the two previous years as well as 2 estimates for the current year (showing last month vs. this month’s updated figures so that one can see the change from last month’s report)
The important thing to remember is that ending stocks are a key figure in what kind of supply environment the market is operating in. It’s the big picture, the stage, if you will, upon which all of the other actors are playing on.
Stocks to Usage
Where as Ending Stocks concern themselves with where supplies will be, Stocks to Usage is a measure of where stocks are as compared to where projected demand will be the upcoming year.
For instance in the chart example, ending stocks are expected to be 1.599 billion bushel. Total demand (or “use”) is projected to be 13.735 billion bushel.
Therefore, Stocks to usage would be 1.599 /13.735 = 11.6%. If there were no corn harvest at all in 2016, the US would be able to meet 11.6 % of 2016/17 demand with what is left over from the 2015 crop (assuming demand remains the same).
Together, ending stocks and stocks to usage are the two most important figure to know when trading any grain or soy market.
Why are Ending Stocks and Stocks to Usage so Important?
These figures are so important because every factor that affects supply and demand gets factored into them. Everything that happens in a grain market, rain problem, bird flu, Chinese imports, Brazilian drought, increased population, harvest delays, all are important to price only in how they affect ending stocks to and stocks to usage. It’s kind of an overall gauge to the environment the market is operating in. It’s your weather report for the market climate.
Prices will move based on how the market thinks various events will affect ending stocks and stocks to usage. Obviously, changes in ending stocks or stocks to usage (both US and World) can have a major impact on price.
It is for this reason, you will often see us talk about both of these figures when discussing corn, soybeans wheat or other agricultural markets. Analyzing the implications of these figures is how we spend much of our time in selecting favorable markets for our clients. But it is the key to price discovery in all grains and well worth the effort in the end.
For one, almost no individual investors are doing it (or know how to do it) and two, it can often give you a range of where prices are likely to remain throughout different market conditions.
Selling options outside of those ranges is how you can potentially monetize it.
Where do you get these figures? The USDA updates ending stocks and stocks to usage for all grains in it’s month Supply and Demand report. You can view this report at www.USDA.gov.
To get a true view of your market conditions for wheat, corn, soybeans or oats, you’ll have to take this year’s figures and compare them to how they stack up to figures in year’s past. Knowing how prices reacted in those years can often point the way to how prices will behave this year. More importantly as an option seller, they can give you a great idea as to how they won’t behave.
Think of it as your bull or bear watch. It won’t necessarily tell you what prices are going to do, exactly. But it will tell if conditions are right for a bull or bear market. As an option seller, that’s gold.
For more information on commodities fundamentals and how to use them to your advantage, see chapters 13 and 14 of The Complete Guide to Option Selling 3rd Edition (www.OptionSellers.com/Book)
If you are a high net worth investor interested in selling options in crude oil and other commodities, you may qualify for a managed option selling portfolio with OptionSellers.com. To learn more, request your Free Investor Discovery Kit at www.OptionSellers.com/Discovery.
James Cordier is the author of McGraw-Hills The Complete Guide to Option Selling, 1st, 2nd and 3rd Editions. He is also founder and president of OptionSellers.com, an investment firm specializing in writing commodities options for high net-worth investors. James’ market comments are published by several international financial publications and news services including The Wall Street Journal, Reuters World News, Forbes, Bloomberg Television, Fox News and CNBC. Michael Gross is director of Research at OptionSellers.com. His published research articles have appeared on Forbes.com, MarketWatch, Optionetics.com, Businessweek.com and Yahoo Finance.
*Price Chart Courtesy of CQG, Inc.
Fundamental Charts courtesy of The Hightower Report
Seasonal Chart courtesy of Moore Research, Inc
***The information in this article has been carefully compiled from sources believed to be reliable, but it’s accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss, and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account size. Before trading, one should be aware that with the potential for profits, there is also potential for losses, which may be very large. All opinions expressed are current opinions and are subject to change without notice.