Uncorrelated Income from the Wheat Market

Uncorrelated Income from the Wheat Market
Jul

13

2018

Uncorrelated Income from the Wheat Market

With Weather Worries Now Behind, Prices May Soon Give Way to Seasonal Pressures

China Trade Tensions Could be Added Bonus

“Call Sellers Market”

As the mainstream investing world wrings its hands over Chinese tariffs and their effects on asset prices, those of us in the option world are already building out strategies for turning this into cash. Bull or bear markets are largely irrelevant to commodities traders -especially option sellers. Either side of the market can be equally productive.

In addition, while geo political events (such as the US/China trade “tensions”) can be a macro wind for some commodities to contend with, daily supply/demand fundamentals carry on. Soybean and corn prices are falling – partially on China trade fears. But the fundamentals in these markets are also bearish. Strategies for taking advantage of those markets were covered in the blog last month.

Wheat , being a global commodity, has largely shrugged off trade fears and focused on its core fundamentals. In doing so, it has broken price pattern with its grain and oilseed brethren. This was largely due to some weather issues experienced by this year’s US winter wheat crop.

But winter crop damage has since been priced into this market . And this market rallied primarily from a US crop issue. Taking a global view can give you an advantage – especially if you sell options. Wheat prices are well off their June highs. But they have not fallen to the degree of the other grains and oilseeds. At this time, several forces are aligning to potentially drive wheat prices lower – or at the very least, prevent them from going higher. This is where opportunity lies for option writers.

Local vs. Global Fundamentals

Make no mistake, the US Winter Wheat crop had some trouble in 2018. A persistent drought in the key growing regions of the North-Central US cut 2018 US winter wheat production by over 6% from last year.

As winter wheat accounts for approximately 75% of overall US wheat production , this has had a substantial impact on 2018/19 US Ending stocks. As of the July 12 USDA Supply/Demand report, US Ending Stocks for the 18/19 crop year are pegged at 946 million bushels – down 12.4% from last year. US Stocks to Usage is down 16.6% from last year’s levels.

But the market spent the months of May and June pricing that reduced yield. As harvest got underway, traders began focusing on incoming harvest supplies.

In addition, US wheat supply is not the whole story. Remember, wheat is a global commodity.


(To learn more about the importance of ending stocks and stocks to usage figures on agricultural prices, be sure to watch our feature video on the subject at www.OptionSellers.com/agriculture . )


Global Supplies Still Abundant

The global supply numbers tell a story of abundance. At 266.16 million metric tons, 2018/19 Global Ending Stocks for wheat will hit the second highest levels on record. Ditto global stocks to usage. Why? Largely the result of large carry over stocks from last year, combined with an overall adequate world harvest (this despite some setbacks in Russia this year.)

Graph: World Wheat Usage Ratio

No shortage here: World wheat ending stocks and stocks to usage will be the second highest on record for the 2018/19 crop year.


In the global picture, the US is a small piece of the pie. While it remains the second largest exporter, the US accounts for just over 9% of total global wheat supply.

Pie graph: World Wheat Production

The US accounts for only about 9% of global wheat production.


The takeaway is this . While the trade has recently focused on lower US winter wheat production, global supply numbers remain adequate, if not burdensome. This alone, can be a good reason to sell wheat calls for premium.

But another factor now comes into play. As the US works through harvest of the 2018 Winter Wheat crop, the Spring wheat harvest begins immediately after – in September. This back to back harvest (and the anticipation of it) has historically been a weight on wheat prices.


While the trade has recently focused on lower US winter wheat production, global supply numbers remain adequate, if not burdensome.

This brings us to the second reason you may want to consider selling calls in this market.

The Seasonal

Regardless of weather, supply, or crop estimates, seasonal tendencies should never be underestimated.

And wheat bulls have another strike against them with the seasonal tendency. As the following chart illustrates, wheat prices have historically began to decline (as winter wheat harvest begins) and continue to do so into the fall (spring wheat) harvest. After all, this is the time of year when wheat supplies will be at their highest levels.

Economics 101 dictates that when supplies are highest, prices tend to fall to their lowest. The seasonal tendency chart below seems to bear this out.

Graph: Wheat 15yr seasonal

Wheat prices have historically begun to decline through summer and into the fall harvest.


Conclusion and Strategy

While trading media and commodities types are ablaze with speculation over a looming trade war, wheat prices have quietly rallied on plain old supply demand fundamentals. Weather in the US reduced the 2018 winter wheat yield – and prices adjusted for it. But the market has likely factored lower yields into price and will now turn attention towards harvest – often a time offalling prices. In addition, global fundamentals remain bearish for wheat – giving the market little foundation for a bullish ride.

In short, it’s a call seller’s market.

We will be watching wheat prices closely for opportunities for positioning our privately managed portfolios in a variety of strikes and balanced strategies.

Self-directed traders can consider selling March wheat 6.50 calls on limited July rallies for target premiums of $400-$500.

March 2019 Wheat

GRAPH:


Selling the March Wheat 6.50 call option.


Any resolution to the tariff situation is unlikely to come before the mid-term elections. This should continue to cast a cautious pall over both equities and some commodities. For option sellers, that can mean cash cows on the table.

It’s hard to see wheat rallying substantially higher given current fundamental and seasonal factors. However, the China situation adds and extra layer of trade security for call sellers.

Thus, while the rest of the investment world frets over trade and tariffs, you can quietly use it to your advantage.

After all, that is what “uncorrelated income” means.

To learn more about managed option selling accounts with James Cordier and OptionSellers.com, visit www.OptionSellers.com/Discovery for a Free Information Package.

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