Posted on Mar 29, 2023, 11:32 by Dave Toth
While this week’s pop is not unimpressive and it stems from the extreme lower recesses of the past year’s range, it is thus far insufficient to counter the past three months’ body of major peak/reversal evidence, especially with a still-frothy 85% reading in our RJO Bullish Sentiment Index. Indeed, with a 134K Managed Money long positions reportable to the CFTC versus only 24K shorts, there remains plenty of fuel for downside vulnerability if the overall market forces further capitulation of this excessive bullish exposure.
As recently updated, a recovery above at least 21-Mar’s 13.17 corrective high and preferably above a suspected 1st-Wave low from 28-Feb at 13.46 remains required to jeopardize the impulsive integrity of a more immediate bearish count that suggests this week’s pop is a (4th-Wave) correction ahead of a (5th-Wave) resumption of the major peak/reversal count. Against this backdrop and heading into Fri’s key crop reports that have the reputation for inciting big moves, this current rebound offers producers a favorable risk/reward hedging opportunity for new crop.
PRODUCER BEAR HEDGE: May Short-Dated 13.10 / 12.880 Put Back Spread
With the late-Mar crop reports having the reputation of inciting big moves and given the key technical levels cited above, we believe it’s most likely that the market will resolve itself in one of two ways post-report:
- reinforcing our longer-term bearish count with a resumption of 1Q23’s major downtrend to new lows below 12.47, or
- negating this count with a sharp reversal above the 13.30-to-13.46-area resistance.
What we believe is less likely is market malaise around recent 12.80-area levels.
The May Short-Dated 13.10 / 12.880 Put Back Spread is structured from the key technical directional flexion points discussed above as well as an expectation of a MOVE AWAY FROM recent 12.80-area prices. This strategy involves selling 1-unit of the May Short-Dated 13.10 Puts around 30-1/4-cents and buying 2-units of the May Short-Dated 12.80 Puts around 17-1/2-cents for a net initial cost of about 4-3/4-cents. This strategy provides:
- a current net delta of -17%
- fixed, maximum risk of 4-3/4-cents on ANY sharp rally above 13.10 that negates our bearish technical count
- maximum risk/cost of 34-3/4-cents if the underlying Nov contract settles at 12.80 23 days from now at expiration on 21-Apr
- virtually unlimited, dollar-for-dollar downside hedge protection below its 12.45 breakeven at expiration.
Additionally, traders are urged to take note of the P&L difference of the red and green lines below. The red line is this strategy’s P&L as of today while the green line is at expiration 23 days from now. The reason behind and need of a protective bear hedge is to prepare for a sharp move lower in the Nov contract, such market performance of which should become pretty obvious in the days or perhaps even hours after Fri’s 11:00 a.m. CT reports. This strategy provides more than enough TIME for us to gauge the market’s post-report behavior before theta (time decay risk) and languishing price action in the contract inhibits this spread’s performance to the point of defensive action against this strategy, like paring or neutralizing it. A sharp recovery above our 13.46 long-term bear risk parameter won’t negate the producer’s need to hedge against this year’s crop, but it WILL negate the immediate need for such a hedge, mitigate the producer’s bear hedge risk/cost and allow for a preferred risk/reward selling/hedging opportunity at some indeterminable price and time down the road.
Dec corn has enjoyed a nice little recovery this week following Mon’s bullish divergence in momentum from the extreme lower recesses of its past year’s major range. To negate a longer-term bearish count, a recovery above at least 12-Jan’s 5.83 1st-Wave low remains required. In effect and like a number of markets across the ag complex, the short-term trend is up within the longer-term downtrend. Per such, this week’s recovery may be providing a favorable risk/reward hedging opportunity for producers.
If there’s a key technical difference between corn and beans that could easily defer a bearish count and need for a bear hedge at this time, it’s the fact that Managed Money long positions have, understandably following a 5-month, $0.90-cent, 14% decline, fallen off a table. Last week’s RJO Bullish Sentiment Index of 45% is the lowest since Aug’20 and MAY warn of a more protracted, if intra-range recovery. To structure a cautious but favorable risk/reward bear hedge that accounts for a steeper recovery as a result of Fri’s crop reports, we turn to a long gamma put diagonal strategy below.
PRODUCER BEAR HEDGE: MAY SHORT-DATED 5.60 / DEC 4.80 PUT DIAGONAL
This strategy involves buying the May Short-Dated 5.60 Puts for around 8-1/2-cents and selling the Dec 4.80 Puts around 8-1/2-cents for a net initial cost of about “even”. This strategy provides:
- a current net delta of -19%
- an enviable gamma ratio of about 6.5:1
- negligible risk if the underlying Dec contract negates our more immediate long-term bearish count with a recovery above 5.83
- profit potential of 0.80-cents on a sustained major decline below last week’s 5.47 low and last summer’s 5.43 low.
There are two drawback considerations to this strategy. First and as always with long-gamma inter-contract spreads, the “theoretical” risk to this strategy is massive. But such a risk will only occur following gross mismanagement of this strategy that would come from merely languishing price action in the contract that would see the long SD May 5.60 put erode to zero while maintaining a naked short position in the dec 4.80 put. With a full three weeks to 21-Apr’s expiration of the May SD puts following Fri’s key crop reports, there will be more than enough time to assess this market’s directional hand and either maintain bearish policy if the market is tanking or cover it for a small loss if the Dec contract spikes above 5.83.
Secondly, this diagonal spread does NOT suffice as an appropriate long-term bear hedge as its downside profit potential is limited to 0.80-cents. This strategy serves as a sort of cautious but favorable “bridge” to get through Fri’s key crop reports. IF these reports cause the major bear trend to resume to new lows below last week’s 5.47 low, additional bear hedge will be needed. IF, alternatively, the Dec contract recovers above 5.83 that will defer the need for a hedge, the risk/cost of this protection against a post-report meltdown will be negligible.
Please contact your RJO representative for updated bid/offer quotes on these strategies and good luck on Fri’s numbers.