We are now in the throes of summer, so that means lots of different outdoor activities: boating, golf, tennis, biking, running, etc. If outdoor activities are on the agenda, so is talk about the weather – heat, rain, wind. But weather is something the ag market has a lot in common with all of us in our social lives. Heat, rain and wind are the topic of discussion because they can impact crop yields immensely. When it comes to temperature, it is not the daily highs that matters as much as the daily lows. These lows, in the Eastern part of the Corn Belt from Illinois eastward, are the highest seen in over 100 years. This matters because high overnight low temperatures during pollination can lead to substandard yields. It isn’t just the temperatures either. As you see from the chart, the rainfall across the country means that the corn and soybean belt has less drought than it would normally have. Does the fact it has been wet offset the high temperatures? Is the adage “rain is grain” all that matters with wet conditions meaning higher yields? No one will know for sure until the WASDE report is out, however, this discussion of heat and precipitation is definitely the focus of the conversation.

In the ag markets, it isn’t just the weather. Or maybe it is the weather but how the traders then position for it. In the corn market, looking at the Commitment of Traders report, managed money is among the shortest it has been in the last 5 years. It is particularly noteworthy that the same traders were near the most long they had been at the start of the year, so the change is very noticeable and having an impact on corn prices. Managed money is not nearly as bearish in soybeans, but positions have dipped net short recently in spite of data from USDA that isn’t as bearish as traders have seen in corn. A very bearish corn positioning picture and a relatively neutral soybean picture lead me to think the set-up for the WASDE report is somewhat different for each product.

The positioning of the two products may be different because the price action has been quite different. In the top chart, I see that once corn prices broke below the Ichimoku cloud in May, they have not looked back. There has been a relentless decline in corn prices, from $5 down to $4, which is adding to the struggles of farmers who are also faced with having to pay higher input prices for fertilizer. The combined picture in corn is not that attractive, so there would be a welcome relief if traders found out that hotter overnight temperatures meant lower yields since the expectations on yields in corn have been very bearish for prices all year long. Soybeans are a little different, with the picture more mixed. Prices have gone sideways and stayed in a 980 – 1080 range all year long. While they recently broke below the Ichimoku cloud, the MACD has started to turn higher, suggesting there could be a change in trend. Sideways with the possibility of a break higher looks to be the message from the charts.

Turning to the volatility markets, despite the low underlying prices, the CVOL Index for Corn is very much in the middle of the range for the past 3 years, giving no strong signal as to what traders are really thinking about price. There doesn’t seem to be any panicked demand for downside protection, nor does there appear to be an overwhelming supply of upside options. In Soybeans, it may be a different picture again. The CVOL Index is near the lows of the last 3 years, possibly reflecting that futures are staying in a relatively tight range. This can provide an opportunity for anyone looking for a change from this range trade, though.

Turning to the Skew Ratios for both Corn and Soybeans, there does still appear to be relative demand in the pricing of upside strike options vs. downside strike options. In the top chart from the Corn market, I see the Skew Ratio has declined from the recent highs of 1.25 in June, but at 1.15 there is clearly more demand for upside options. Perhaps this comes from funds that are short futures and using the upside options as a hedge. The same is true for Soybeans in that the Skew Ratio is near 1.15, it is just that this level is near the highest levels seen over the past 3 years. In both markets, there is consistently more relative demand for upside than downside, something traders can take advantage of whether they are bullish or bearish underlying prices.

Now when I look at the QuikStrike volatility tools, I want to see if there are expirations where the relative pricing stands out compared to the other expirations around it. It is important to also consider that I want to have an options spread that covers the next catalyst, the WASDE report on August 12. While the further out in the implied volatility I go, the more relative preference for upside vs. downside I see, I don’t want to go out too far as those expirations will not be as responsive to changing futures and options prices for expirations nearer the catalyst. The last couple weeks of August look to be the sweet spot for relative pricing and price elasticity.

In both Corn and Soybeans, the Skew Ratio favors upside options, so I want to use that information. Soybean CVOL is near its 3-year lows, but corn CVOL is in the middle of the range. Managed money in Corn is very bearishly positioned but has been right to be as WASDE yield data is bearish and prices have broken down. While there is every reason to believe this will continue, there are fewer people left to put the trade on and hotter than normal temperatures could be an end to the decline in prices. In Soybeans, positioning is light, and price has been in a range. The MACD is turning up and the weather may also reduce soybean yields, and any positive news on demand from China as part of a trade deal would be well received.

To take advantage of different setups for the trade, I have chosen two very different trades. In Corn, I looked at New Crop Weekly options expiring in a little over 3 weeks. The CN3Q5 expiring the third week of August captures the WASDE data. For Corn, I use a bearish jade lizard. The jade lizard is a trade that is short volatility and aims to take premium out of the market. The strikes are chosen intentionally so there is no risk on one side of the trade, even though the other side of the trade has all of the risks of short volatility. What do I mean? This spread is short a 425 – 430 call spread where the max risk is -$5. It is also short a 405 put, though and the total premium taken in is 5.58 which means even if futures move above the upper strike, the trader will still make a small amount of money. The trader can potentially earn all of this premium if futures stay in the 405 –- 425 range, the sweet spot of the spread. How could this happen? If data is neutral or even modestly bearish, but given heavy short positioning, any selloff is met with short-covering by managed money. The risk for the trade in this spread is a move below 400, which is the breakeven on the downside. A trader who's already short Corn and looking for a way to leverage their position for a modest move lower or non-event may find value in this strategy. It doesn't add to upside risk and the option breakeven below 400 means a trader might be taking profit on their short futures there.

In Soybeans, I went in a different direction, literally. I have chosen a bullish broken wing butterfly where the strikes are not set up to be symmetrical. Instead, I use a long 1030 call, short 2 of the 1060 calls and long 1 of the 1080 calls. The best case for this spread is if futures prices move higher but stop at 1060, which also happens to be the upper end of the Ichimoku cloud. This is a modestly bullish idea for a product that has been in a range. If prices really accelerate and breakout to the upside, traders still make money because I use asymmetric strikes. So, the worst case is the trader makes $10 but has paid $5 in premium so even on a move above 1080, the trader makes $5. If futures go to 1060 and sit, the trader makes $25 ($30-5). The worst case scenario is staying here or moving lower, in which case the trader would lose all of the premium invested.

Both ideas try to take advantage of selling relatively more expensive upside options. However, each idea is different in what the trader is rooting for – a nonevent in the case of Corn and a move higher in the case of Soybeans. In each case, I use the New Crop Weekly contracts that expire in the third week of August after the WASDE catalyst. The combination of the tools to analyze the trades plus the flexibility of strikes gives traders everything they need to be successful. Now we just need the weather to cooperate!

Good luck trading.

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