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.

  1. With the recent spike in Wheat price which I assume is due to the news of global shrinkage of the wheat crop. Do you think the fundamental has changed? Thanks

  2. kanu bhatia Says:
    August 2, 2018 at 5:31 am

    James & Michael,
    Thanks for your Newsletter and trade recommendations, It’s wonderful I just close out 2nd. quarter in green by just short of 10k.I consider taking just your trades, got little creative call it ‘art of trading’ start taking several positions further out that has added considerable premium to my account it’s boring but don’t mind waiting to get paid $$$.
    Like to know if you have any you tube how to read & analyses all govt. reports so much info can’t make head & tail, It will be a great help.

    Wish had started when read your 1 st edition book from library, keep up the great job your team puts out thanks is not the big enough.
    kanu

  3. James,

    First of all thank you for sharing with us this trade idea. I was just wondering if there are any simple ways to know or any rule of thumb that amateurs can use to determine whether the fundamentals of a commodity surrounding an option trade have changed? I think that keeping track of all the factors determining the supply/demand dynamics is too much for a non-professional. With the recent price spike I’m relying on my stop loss and the USDA report next month so I’m staying still for now and watching the news everyday.

    Thanks

    • Michael Gross Says:
      July 31, 2018 at 2:53 pm

      Tom,

      Good question. Unfortunately, it does not have a simple answer. The only way to know if fundamentals have changed is to know them in the first place. If you are doing this on your own, my advice is to study, study, study. However, you are doing the right thing by sticking to your risk parameters. If you follow them diligently, you should stay out of trouble, even if you are a novice at gauging fundamentals.

      I hope that helps.
      Regards,
      James

  4. I heard the reason for the recent price run-up in wheat was production was down. When I look at the production numbers, it shows the US production is down by almost 10%; however, world production is slightly up, about 1.8% (compared to last year). What matters most, US or world, as far as fundamental pricing?

    • Michael Gross Says:
      July 31, 2018 at 3:04 pm

      Calvin,

      Both matter. In the bigger picture, world wheat should matter more. However, for the CBOT wheat contract traded in Chicago, US numbers carry some heavy weight. In short, consider both in your analysis. Also, crop size matters but ending stocks and stocks to usage matter more. Those are the numbers to follow. To learn more about these, you can watch our video at http://www.OptionSellers.com/agriculture.

      Thanks and good luck to you!

      Michael

      • Michael,
        I’m taking a little heat in wheat and just trying to understand why it is spiking. Seems there may be over-reaction to the China war, so waiting patiently for fundamentals to kick in. I appreciate the video link and everything you do. I am learning so much from your book and website.

        Thanks again for your help.

        Calvin

      • Michael Gross Says:
        August 3, 2018 at 1:50 pm

        Calvin,

        Wheat is reacting to lower production numbers out of the EU and Australia. However, we continue to feel global ending stocks will eventually curb prices. If you sold calls early, the conservative strategy is to roll into higher strikes.

        Regards,
        Michael

  5. Celine Mak Says:
    July 26, 2018 at 8:38 am

    From 25 July to 26 July ( 2 days) wheat prices has gone up $49. Is there any specific factors that account for the substantial increase?

    • Michael Gross Says:
      July 31, 2018 at 3:14 pm

      Celine,

      That is a really good question that I am glad you asked. Our longer term outlook for wheat is one we feel will be favorable towards call selling. Shorter term, markets react to news events, technical factors or even external events having little to do with it. Markets can move randomly in the short term. This is WHY you sell options in the first place – you AVOID trying to guess short term direction of prices. Wheat is in a spec led buy cycle right now. Speculators are reacting to lower yields in the EU, Australia, and to some extent, Russia. These are shorter term issues that have been heavily reported in the news. They have traders reacting. Longer term fundamentals, however, paint a different picture. World Ending stocks appear adequate if not burdensome (as we state in the article.) I don’t know, or pretend to know when and where the wheat market will top. However, our strategy will be to use the current strength to sell inflated, distant call premium. Eventually, the longer term fundamentals should catch up to prices.

      I hope that helps.
      Sincerely,
      Michael

  6. john jabbour Says:
    July 17, 2018 at 6:35 pm

    Thanks for your Newsletter and trade recomendations

  7. SETH HIRSH Says:
    July 15, 2018 at 2:57 am

    James,
    Brilliant analysis of wheat !! Thanks.

    Seth

  8. Paul Matthe Says:
    July 13, 2018 at 4:04 pm

    James,
    Thanks so much for yet a great idea!
    After reading your book and following the blog I have done a few of the discussed trades and they are doing fine so far. Some even had a very quick drop in premium and that triggers my question. Do you close out a position if it has made say 70-80% of potential profit before even hitting the halfway mark to expiration? How do you decide when to take profit?
    Greetings from Belgium!

    • Michael Gross Says:
      July 18, 2018 at 2:17 pm

      Paul,

      Thank you for your feedback. Yes, we do at times close positions early when they have realized the lions share of potential profits. I suggest watching our video seminar on the “buyback.” You’ll find it on this blog. Thanks.

      James

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