Some Traders Take $12 Corn Futures Price Positions
Tuesday, August 30th, 2011
Corn's doubling over the past year, to more than $7 a bushel, is squeezing livestock feeders and forcing supermarket meat prices higher. Some traders in Chicago have placed bets on a continued rally that may make current prices look like a relative bargain.
Earlier this week, traders held more than 4,500 call options in CME Group's corn market at strike prices of $11 and $12 a bushel, according to exchange reports. The number of such positions was up 15 percent from a month earlier, an indication of growing concern this year's harvest will fall short of expectations.
Before last year, corn call options hadn't ever reached such lofty levels, veteran Chicago traders say. But concern over shrinking grain supplies has intensified this summer as a Midwest heat wave hit corn during its crucial reproductive phase, making a $10 or higher price a possibility, some say.
Kevin Van Trump, who runs Farm Direction, a Kansas City-based advisor, said $9 or $10 corn could happen, given the prospect the U.S. Department of Agriculture, after trimming its yield and production estimates earlier this month, will make further cuts.
"There is a lot of talk now that the USDA will need to lower yields even further," Van Trump said in an Aug. 24 report. "The bottom line is that with yields continuing to shrink and thoughts fewer acres will be harvested, the trade simply sees very few options but to continue adding more premium to current prices."
Buying a call option grants the right, but not the obligation, to buy an asset at a set price in the future. While there are numerous futures and options combinations used by traders, a call by itself typically represents a bullish position that pays off if the price of the underlying asset rises above the strike and the option can be exercised at a profit.
Corn futures traded on Chicago-based CME have already climbed to the highest levels in over three years, extending the rally this week as the Pro Farmer crop tour through the Midwest revealed many heat-damaged fields.
In trading Aug. 26, corn futures for December delivery rose 23 1/2 cents to $7.67 a bushel. That's the highest settlement for a December contract since July 2008, when prices surpassed $7.80. Since corn futures trading began in 1877, the highest price reached by any single contract is $8.22 in June 2008.
Based on the tour results, Pro Farmer analysts estimated the corn crop will generate an average yield of 147.9 bushels an acre nationwide, the consulting firm said on its website Aug. 26. Pro Farmer's estimated yield is 3.3 percent below the USDA's current forecast of 153 bushels an acre and would be the lowest U.S. yield since 2005.
In the CME corn market, futures prices indicate prices will remain above $7 a bushel through at least the middle of next year. Some traders in the options market apparently have had even more of a bullish posture.
Last fall, $10 corn call options traded for the first time, with large trading firms including JPMorgan Chase & Co. and MF Global Holdings Ltd. among the buyers of those calls, according to CME traders. It's unclear who holds the more-recent positions in $11 and $12 calls.
Whether corn gets anywhere close to $11 or $12 remains to be seen, but the prospect of even higher prices is sure to send shudders through the beef, pork and poultry industries, where profits have already mostly evaporated as feed costs rose this year.
If corn rose to $10 or higher, there would be severe implications for the beef and pork industries, analysts say, with many producers probably forced to liquidate herds as losses grew. In 2008, a spike higher in corn combined with recession triggered a previous round of herd contraction.
Corn at $10 "will put a lot of sows in packing plants," University of Missouri economist Ron Plain said.
According to Dan Vaught, who runs Vaught Futures Insights in Altus, Ark., "it's pretty obvious that hog producers would liquidate herds pretty quickly" with $10 corn, while feedlot operators "would very likely curtail placement rates rather dramatically."
"Still, the reaction might not be as drastic as one might first guess," Vaught said, "because the deferred live cattle and hog contracts would probably soar along with the corn market, thereby offering livestock producers incentives for sticking with production plans."