In This Report
- Generic front month corn and soybean daily Ichimoku charts
- Commitment of Traders report for Corn and Soybeans
- Relative price move of generic front month corn vs. soybeans
- CVOL chart for all Ag products and CVOL comparison of corn and soybean
- Cross-Asset Correlation tool showing correlation of Log Returns and Implied Vols
- Event Volatility Calculator for WASDE report for corn and soybeans
- Expected return chart for long 3 November Corn 440 calls vs. short 1 November Soybeans 1100 calls
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Generic front month corn (top) and soybean (bottom) daily Ichimoku charts
The September USDA WASDE report ended up being a catalyst for price action, even if it was not the price action that the headline details may have suggested at the outset. The USDA’s corn outlook showed a modest production increase up to 15.186 billion bushels. However, analysts were expecting the USDA to move that number in the opposite direction with a consensus estimate of 15.076 billion bushels. Also, The USDA unexpectedly raised its estimates for per-acre yields to 183.6 bushels. The soybean figures aligned more closely, with the USDA slightly lowering its production estimate to 4.586 billion bushels and keeping per-acre yields steady at 53.2 bushels per acre.. On the surface, most analysts expected these results to be bearish for corn and neutral for soybeans. However, as you can see in the chart above, corn has risen since that report and is on the verge of breaking out above the Ichimoku cloud, with MACD trending higher and the RSI not at overbought levels. Soybeans have also risen but have not yet broken out, trailing the surge in corn prices. How does that happen?
Commitment of Traders report for Corn (top) and Soybeans (bottom)
In the classic trading book 'Reminiscences of a Stock Operator,' Jesse Livermore cautions that prices don't always decline on bad news. The fictitious trader discusses how that is a sign that everyone who can be short is already short, suggesting that this price action lays the foundation for a potential short squeeze higher. Corn got bearish news, and while it initially tried to go lower, it ultimately turned around and is now breaking out after a year of relentlessly bearish price action. One reason this may be happening could be that managed money has been covering shorts into the report and especially after the report. From the Commitment of Traders Report, one can see in the top chart that the corn short is in the process of being covered from the shortest it had been in five years. A trader can also see that the short base in soybeans was also at a five-year high and is in the process of being reduced but not quite to the magnitude of corn. With another catalyst coming up in the October 11 WASDE report, could markets continue to see length added?
Relative price move of generic front month corn vs. soybeans
When looking at the relative price of corn vs. soybeans, one could make the argument that corn is not only breaking out on an absolute basis, but also on a relative basis. Corn and soybeans had traded roughly between 0.34 and 0.38 for the better part of the last year. In the last two months, corn has broken above the 0.38 level, re-tested that level, and is now moving higher. Drawing a trendline from the July lows to the current price suggests more upside. While the price on a one-year basis may look elevated (top chart) if a trader were to step back and look at the relative price on a multi-year basis, they might see there could conceivably be much more upside. The high in this ratio over the last three years is 0.50 vs. the current 0.40 level suggesting the potential for a continuation of the move that markets have seen lately. The possibility of a 25% relative move is nothing to minimize and going back to 2021, one can see the pair had traded in the 0.4-0.5 range vs. the more current, lower 0.34-0.38 range. Is this breakout just a normalization of the longer-term relationship?
CVOL chart for all Ag products (top) and CVOL comparison of corn and soybean (bottom)
The next stop is the CVOL tool and an assessment of the relative volatility of each product. The top chart looks at the entire Ag space and where CVOL, UpVar, DownVar, Skew etc. have been for the last year. One can see it is a bit of a mixed bag. What stands out to me is that corn CVOL is near the lows of the last one year while soybeans CVOL is closer to the highs of the last year. This led me to chart the two of them against each other, which you can see in the bottom chart. Here you can see that over the last year, corn has rarely traded below soybean CVOL like it is now. In fact there have been several times when corn CVOL was almost 50% higher than soybeans. These levels are not predictive; however, they indicate that going long on Corn options relative to Soybean options is approaching an entry point that is at or near the lows seen in the past year. Additionally, corn volatilities have demonstrated the potential to trade significantly higher than soybeans.
Cross-Asset Correlation tool showing correlation of Log Returns (top) and Implied Vols (bottom)
A trader may think that it is nice to look at those levels, but are corn and soybeans as correlated as they might think? In order to assess this, a trader can look at the CME Group Cross-Asset Correlation tool. Here, I look at all grains as well as cattle to show the correlation of returns (top chart) and implied volatilities (bottom chart). Comparing corn and soybeans, one can see that returns have a correlation of 0.59 while implied volatilities have a correlation of 0.63. In my experience, any correlation above 0.50 can be considered strong enough to consider relative value trades. This is particularly true if that correlation is persistent through time, which it is in the case of corn and soybeans. The Cross-Asset Correlation tool supports the idea that I can consider a relative value trade.
Event Volatility Calculator for WASDE report for corn (top) and soybeans (bottom)
Now I go to the CME Group Event Volatility Calculator to see if traders are pricing in any incremental volatility coming from the WASDE report. I bring up each product and input the WASDE date. In the top chart, one can see that the volatility for the WASDE event is actually lower for corn at 16.69 vs. volatilities 18 or higher normally. For soybeans, there is no sign of volatility differences for the WASDE event. The market is not expecting the September WASDE report to be a catalyst for volatility at all, and in the case of corn, might actually see it as a volatility dampening catalyst.
Expected return chart for long 3 November Corn 440 calls vs. short 1 November Soybeans 1100 calls
The set-up is suggesting that there could be the scope for a continued breakout of corn on an absolute basis and relative to soybeans. The relative price chart has broken above the 0.38 range and may be moving back into the 0.40-0.50 range. This is driven by the reduction of the short from managed money from five-year lows though it is not back to flat yet. The products are strongly correlated and one can see that the CVOL for corn appears to be low relative to soybeans as well. Finally, corn CVOL is near the lows of the year and the Event Volatility Calculator suggests little if any volatility is being priced into the WASDE report.
This backdrop suggests to me that I want to be directionally bullish corn relative to soybeans, I want to be long corn volatility relative to soybeans, and I want to be net long corn options. I also want to look a little further out than the late October expiration because it took about a week for futures to move after last month’s report, so I want to give it time to play out.
This all suggests that I should buy out of the money corn calls and sell out of the money soybean calls to fund it. I decide on a ratio of three corn calls to one soybean calls though that is leaning slightly long on the ratio. If I do this, I am able to pay 2.73 per corn option or a total of $409.50. At the higher volatility, I am able to take in 7.36 per soybean call or $368. I am net spending some money but if both futures move higher, especially if corn outperforms to the upside, I have potentially unlimited upside. If both futures move lower and all calls expire worthless, I lose a small amount of premium, but not as much as if I just bought corn calls and did not do a relative value trade. My biggest risk is futures move higher and soybeans outperform, perhaps going back to 0.34 ratio. Let’s say it goes to the 1100 strike by November expiration and the ratio falls to the lows of the year. In this scenario, corn would be at 374 so my corn calls would be worthless while my soybean calls could be in the money. I think the ratio going back to the lows in a bull market for both is a lower probability, but this is definitely my risk.
The good news for traders is that CME Group provides all of the tools needed to determine what the right implementation for ideas may be, particularly ahead of important events like the WASDE report on October 11. While traders still take risks as a matter of course, finding good asymmetric reward to risk opportunities is still a fine goal and much easier on the CME Group platform.
Good luck trading!
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