Summing up yesterday’s Technical Blog, the intermediate-to-long-term trend is clearly down and expected to continue with a recovery above last Fri’s 9.17 short-term but critical corrective high and short-term risk parameter minimally required to threaten a bearish call sufficiently to warrant its cover ahead of a larger-degree correction or reversal higher. The market’s encroachment on the pivotal lower boundary and low-quarter of the huge, lateral multi-year range warns us to be watchful for any bullish divergence in momentum that could incite another protracted intra-range recovery or resumption of a multi-year base/reversal threat. In lieu of at least sub 9.17+ strength however, we don’t want to underestimate the current bear’s downside potential, including a break of Nov’15’s obviously pivotal 8.44 low that could expose a meltdown thereafter.
A bearish policy remains advised with a recovery above 9.17 required to step aside in order to circumvent the heights unknown of a larger-degree correction or major reversal higher. Below we discuss two bullish option strategies that would apply to end-user/hedgers and spec traders and a bearish strategy for producer/hedgers.
END-USER BULL HEDGE: SHORT OCT 8.80 – 8.60 PUT SPREAD / LONG OCT 9.90 CALL COMBO
Given what has been and could remain massive, multi-year support around the 8.50-area, end-users can take advantage of this threshold to sell the Oct 8.80 – 8.60 put spread for around 8-cents and buy the Oct 9.90 calls around 13-cents for a net cost of 5-cents. This strategy provides:
- a current net delta of +0.23
- favorable margins
- fixed and minimum cost/risk of 5-cents if the underlying Nov contract settles anywhere between 8.80 and 9.90 at expiration 85 days from now on 21-Sep
- fixed, maximum loss of 25-cents on ANY decline below 8.60
- unlimited, dollar-for-dollar upside hedge protection above its 9.95 breakeven at expiration on 21-Sep.
BULL SPEC: AUG SHORT-DATED 9.20 / OCT 9.90 CALL DIAGONAL
For those speculators who’d like to safely bottom-pick the underlying downtrend for the bullish warning signals we discussed above, this Aug short-dated 9.20 / Oct 9.90 call diagonal strategy has favorable risk/reward merits and will allow a good night sleep tonight as this spread’s downside risk is negligible if the current downtrend continues. Trading at roughly the same 13-cent price, this call diagonal costs about “even” and provides:
- a current net delta of +0.14
- favorable margins
- negligible risk if the downtrend in the underlying Nov contract continues
- profit potential of up to 70-cents if the market reverses sharply and sustains gains above 9.20.
As always the risk of such long-gamma strategies is theta, or time decay. A dud of a report tomorrow and subsequent languishing price action in the weeks ahead would see the premium in the long Aug short-dated 9.20 call erode to zero and leave an eventual naked short position in the Oct 9.90 calls that would present unlimited risk. We NEVER want this strategy to reach this point, so if the market doesn’t show its directional hand either way as a result of tomorrow’s crop reports, then by mid-to-late next week this strategy should be covered for what should be a small loss.
PRODUCER BEAR HEDGE:
While the Nov contract could be considered deep in the proverbial hole by trading near the lower boundary of a multi-year range, producers cannot afford to ignore the risk of a breakdown below Nov’15’s 8.44 low to what would be indeterminable and potentially severe losses thereafter. By the same token, producers should want to limit the cost/damage of bear hedges initiated “down here”. This can be done in one or both of two ways: by neutralizing bearish exposure on a technical momentum failure above 9.17 and/or by establishing a bear hedge that has limited risk to the upside.
One such strategy is the Aug short-dated 8.80 – 8.70 put back spread. This spread involves selling 1-unit of the Aug short-dated 8.80 puts around 22-cents and buying 2-units of the Aug short-dated 8.70 puts around 190-cents for a net cost of 16-cents. This strategy provides:
- a current net delta of -0.32
- favorable margins
- fixed, maximum risk/cost of 16-cents on ANY rally above 8.80 (and this risk can be reduced if this strategy is covered on a recovery above 9.17 in the Nov contract
- maximum risk/cost of 26-cents if the Nov contract closes at 8.70 29 days from now on 27-Jul expiration
- virtually unlimited dollar-for-dollar downside hedge protection below its 8.44 breakeven, or exactly where a produce would need such downside protection if the market breaks Nov’15’s 8.44 multi-year low.
Please contact your RJO representative for updated bid/offer quotes on these strategies.
