Posted on Jul 11, 2023, 10:47 by Dave Toth

Amidst all of the tremendous volatility of late, it’s hard to rely on almost any level as one around which to objectively toggle directional exposure and manage risk.  In 05-Jul’s Technical Blog we identified 28-Jun’s 12.57 corrective low as our new key bull risk parameter.  IF this market has anything broader to the bull side in mind, it shouldn’t come anywhere close to that corrective low, let alone take it out.

From a shorter-term perspective, we’re defining 03-Jul’s 13.83 high as one of developing importance following a bearish divergence in very short-term momentum.  Especially as this contract has quickly and violently rebounded to the upper-quarter of the past YEAR’S range, it’s not hard to imagine that 13.83 high as the end of a 5-wave sequence up from 31-May’s 11.35 low and start of a more protracted correction or reversal lower.

In sum then and considering that recent high implied volatility and tomorrow’s key crop report could see either of these thresholds blown out in an instant, traders are advised to use 13.83 and 12.57 as their key directional toggle points and risk parameters commensurate with their personal risk profiles.

The daily (above) and weekly (below) log close-only chart show the:

• explosion in historical volatility (that isn’t likely to wane anytime soon with tomorrow’s key crop report)
• quick return to the upper-quarter of the past year’s range and resistance
• waning upside momentum on a daily basis (divergence confirmed below 29-Jun’s 12.64 corrective low close)
• spike in our RJO Bullish Sentiment Index of the hot Managed Money positions reportable to the CFTC.

The brunt of these factors questions the risk/reward metrics of a longer-term bullish policy “up here” around 13.50-area prices.  Nonetheless, the extent and impulsiveness of May-Jun’s rally as well as the 3-wave and arguably corrective structure of May’22 – May’23’s sell-off attempt in the Nov23 contract warrants awareness of a more protracted move north until/unless threatened by a relapse below the late-Jun corrective low(s) at 12.57 on an intra-day basis and/or 12.64 on a closing basis.

From an even longer-term perspective however, the monthly log active-continuation chart below shows that the market as yet to provide the evidence necessary to threaten what we believe is a massive, multi-quarter peak/reversal process from Jun’22’s 17.84 high ahead of a new secular bear market.  All these factors considered, and from a pure direction and risk/reward standpoint, we advise a cautious bearish stance for shorter-term traders with a recovery above 213.83 negating this call and warranting its cover.  A neutral-to-cautiously-bullish stance is advised for longer-term commercial players with a failure below the 12.64-to-12.570-area negating this call and warranting its cover and reversal into a bearish stance.

With regards to hedgers, producers cannot afford not to hedge “up here” against a bearish surprise from tomorrow’s crop report while, at the same time, addressing the risk/cost of such a bear hedge if the past month’s upside rocket continues.  Similarly but conversely, end-users cannot ignore the prospects of a continued upside rocket while acknowledging and addressing the risk/cost of a major reversal lower.  In the strategies below, using back spread strategies, we discuss what we believe are the best risk/reward ways to address these challenges.

PRODUCER BEAR HEDGE: AUG SD 13.50 – 13.20 PUT BACKSPREAD

Given the technical conditions discussed above, producers are advised to consider the Aug Short-Dated (SD) 13.50 – 13.20 Put Back Spread as an effective way to hedge against a sharp reversal lower while also minimizing risk/cost if the past month’s bull explosion continues.  This strategy involves selling 1-unit of the at-the-money Aug SD 13.50 Puts around 25-1/4-cents and buying 2-units of the Aug SD 13.20 Puts around 13-1/2-cnts for a net initial cost of about 1-3/4-cents.  This strategy provides:

• a current net delta of -14%
• negligible and fixed risk/cost of only 1-3/4-cents on ANY price rally above 13.50
• maximum risk/cost of 31-3/4-cents if the underlying Nov contracts settles at 13.20 10 days from now on 21-Jul
• virtually unlimited, dollar-for-dollar downside hedge protection below its 12.88 breakeven point at expiration.

Only a glance at the P&L graph below shows that this strategy defines and focuses maximum risk at relative INaction and the market flatlining around the 13.20-area in the period ahead.  Given recent extreme historical volatility AND tomorrow’s key crop report, odds would seem to favor anything but boring, lateral price action in the period immediately ahead.  IF the market goes into a sideways funk as a result of tomorrow’s “key” crop report, then producers will live to fight and hedge another day.  If the market reacts violently either way, then the risk/reward merits of this bear hedge should prove beneficial to producers.

END-USER BULL HEDGE: AUG SD 13.50 – 13.90 CALL BACK SPREAD

This strategy is an identical, only inverted version of the put back spread discussed above and involves selling 1-unit of the at-the-money Aug SD 13.50 Calls around 28-3/4-cents and buying 2-units of the Aug SD 13.90 Calls around 15-cents for a net initial cost of about 1-1/4-cents.  This strategy provides:

• a current net delta of +9%
• fixed and maximum risk/cost of only 1-1/4-cents on ANY collapse below 13.50
• maximum risk/cost of 41-1/2-cents if the underlying Nov contract settles at 13.9i0 at expiration 11 days from now on 21-Jul
• unlimited, dollar-for-dollar upside hedge protection above its 14.31 breakeven point at expiration.

Here too, gist of this strategy is defining the greatest risk/cost as a result of an INactive market where prices trade merely laterally around the upper-13-handle-area in the period ahead.  If such boring, lateral price action is what the market provides as a result of tomorrow’s “key” crop report, then everyone will live to fight and hedge another day.  If the market ether explodes higher OR collapses below 13.50, the risk/reward merits of this bull hedge will prove beneficial to end-users.