Trading Weather-driven Grain Markets

September 30, 2017 01:22 PM
The plethora of derivative products in the grain complex provides opportunities for profitable trades in weather-driven markets.

Using Options
Options trades are also possible; buying wheat puts until the price of wheat falls to the level of corn or below in terms of cumulative percentage price changes. After wheat achieves a lower price, buy September or December calls on wheat and look forward to the next short-term peak in price.

Trading ETFs in place of grain futures contracts is dependent on the close fit in price movements between ETFs and futures. ETFs that do not have a bullish or bearish bias usually have the objective of reflecting the price changes in near-term futures contracts. If the spreads between futures prices decline, price differences between the ETFs that follow them should correlate closely.

Options on the grain futures are also potential sources of trading profits as the result of weather effects on grains. “Wheat and corn calls” (below) shows that the option price curve for calls on wheat is higher than the corn option price curve. This difference is expected due to the options market noting the weather-related surge in wheat futures prices compared to the price movement in corn futures as well as wheat’s normal higher volatility. In the March to July period wheat was more volatile than corn, and the higher volatility is reflected in a higher call price curve.

An option price model for corn futures is shown in “The skinny on corn options” (below). The dollar variances between market prices for the calls and prices predicted by the log log parabolic (LLP) options pricing model are too small to suggest trades taking advantage of underpriced or overpriced calls. However, the upper and lower breakeven prices (futures prices at expiration that would result in zero profit from a delta-neutral spread trade between calls and an underlying futures contract) indicate the options market’s forecast of price ranges near expiration in December for corn futures. The breakeven price spread is $4.55 to $3.51, compared to the current December price for corn of $4.0475.

For strike prices near the current wheat futures prices on July 11, 2017, the breakeven prices for wheat are $6.38 to $4.72; an average of $5.55.

The averages, or mid-range breakeven prices, are close to the underlying futures prices on July 11 as the options market forecasts a spread up and down from the current price. A trade planned to take advantage of the current price differences would result in a maximum profit, using the lower breakeven price for wheat and the upper breakeven price for corn, of the futures price spread.

Trades in July 2017, based on futures contracts expiring in December 2017, include Delta-neutral spreads on corn, wheat, soybeans and live cattle. Each trade is made in reference to the upper and lower breakeven prices for calls because those are expiration price ranges that the options market considers reasonable in light of predicted volatility of underlying futures prices.

An example of the delta neutral trades is shown in “The skinny on corn options” and “Delta neutral” (below).

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About the Author

Paul Cretien is an investment analyst and financial case writer. His e-mail is