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Executive summary

In this report, Rich discusses the current state of global agriculture trends, including upcoming catalysts such as the Black Sea Agreement and the WASDE report. He also explains how traders can use the growing volume in weekly options to express views on these potential catalysts.

There have been fairly major crosswinds blowing through the agriculture markets. One of the most significant challenges is the rapid growth of the middle class in Asia. In 2020, the middle class in Asia was about two billion people, or about 26% of the global population. This is expected to grow by 75% by 2030. This growth will have a major impact on food consumption demand and trends.

Not only is the middle class growing, but the total population is growing as well. We hit a milestone this year,  India’s population surpassed China’s and is expected to continue to grow, while China’s population has presumably hit its peak. The total population in Asia is still continuously rising but the relative make up will be shifting in the coming years. This will also have an impact on food consumption and trends.  While this is bigger picture stuff, I mention it because these powerful forces will have the eyes of those in the food supply chain as well. 

The disruptions in the food supply chain in 2022 caused many problems for people around the world. These disruptions were the result of trade disruptions in addition to weather conditions. Given the fact that a major source of global wheat and global fertilizer was part of the disruption, this was felt more acutely in some areas than others. Even as we have entered 2023, the effects of the unharvested Ukrainian wheat or Russian wheat that has limitations on exports may continue to impact the global supply chain. 

Image 3: Did a food crisis start in 2022?

The Black Sea Agreement set terms by which Ukrainian and Russian product could come to market. This agreement was set to expire on March 18 but was pushed forward by 60 days until May 18. Both sides met on May 3 to discuss terms for a longer extension of this agreement, but uncertainty still prevails.

Image 4: Black Sea Agreement Extension

ANKARA/UNITED NATIONS, March 18 (Reuters) - A deal allowing the safe Black Sea export of Ukrainian grain was renewed on Saturday for at least 60 days - half the intended period - after Russia warned any further extension beyond mid-May would depend on the removal of some Western sanctions.

Source: Reuters

Part of the source of disagreement in these talks is that Russia still wants more access to global markets for its fertilizer products. Russia also wants to no longer be blocked by the SWIFT network, otherwise known as “obstacles to exports,” given these products are still priced in dollars. 

Image 5: Black Sea Agreement Considerations

The Ukrainian grain exports have the most potential to impact wheat. Russian fertilizer will have a bigger impact on corn, which is more fertilizer intensive. For each of these crops, the demand in Asia is a major source of potential impact given the previously mentioned demographic and consumptions trends. 

Image 6: Demand for Wheat in Asia

Rising global food prices were a major factor in the global inflation we saw in 2022, but they are finally starting to subside. It is hoped that lower food prices will help to reduce inflation and alleviate some of the stresses that are being felt around the world. Any disruption to this trend in food prices could potentially cause inflation to re-accelerate, which will then cause social issues. 

Image 7: UN Food Price Index vs. Bloomberg world economy-weighted inflation

Seasonal factors have typically led to higher food prices in the first half of the year, but this pattern may not hold given the major swings in food prices we have seen in the past year. However, many of these patterns are the result of the expectations and reality around planting intentions, which naturally fit a seasonal pattern. Are the seasonal drivers another potential upward bias to food price?

The broader supply and demand factors impacting these measures of UN food prices are clearly related to the prices we are seeing in Agricultural futures markets. We can see the downward pressure on food price is the result of a fall in an index of Corn, Soy, and Wheat futures. Will a change in futures prices be the catalyst to the change in food prices

Image 9: UN Food Price Index vs. a Geometric Index of Corn, Soy, and Wheat

It isn’t just grain that is affected either as corn is clearly feedstock for animal protein as we see in the tight relationship between Corn futures and the UN Meat Price Index. 

Image 10: Corn futures vs. UN Meat Index

Where is meat largely produced? If you guessed in Asia, you would be right. China is the leader in meat production, while India is the third. Thus, any changes in the price of corn are going to have an impact on the meat industry in Asia on both the production and the consumption front. 

Image 11: Global meat production

Are the options markets forecasting any potential disruption in agriculture markets in the near term? Interesting, it does not really look that way. I look at where implied volatility levels are now versus the last six months to see how nervous markets may be using CME Group’s CVOL tool.  For most products, volatility is in the middle if not the lower quartile of the range. The only product with elevated volatility is in corn. 

Image 12: CVOL for Agriculture options

If we drill into the corn volatility market, we can see that the move in volatility has happened only recently and is coincident with the move lower in futures and the move lower in skew. The market looks more worried about a down move in futures versus an up move in futures. This may be a function of market positioning or expected end-user flows, but while a move higher in Corn futures could be more disruptive for the end consumers in Asia (and elsewhere), the market is reacting to moves on the downside more than the upside. 

Image 13: CVOL and Skew for Corn plotted vs. Corn futures

If we look at the same graph for wheat, we see a market that is decidedly less nervous even as the price of wheat continues to probe new low levels. CVOL and skew have been low and stable for all of 2023.

Image 14: CVOL and Skew for Wheat plotted vs. Wheat futures

Next, I want to drill into where the interest is within the options market. I focus on the dark green areas, as those are the areas with the highest open interest. A few things stand out to me. First, there appears to be more interest in puts than in calls. Second, there is growing interest in weekly options. Third, there is interest around two upcoming catalysts, which are the WASDE report on May 12 and the Black Sea Agreement on May 18.

Image 15: Open interest for Corn options over the next 30 days

Doing the same for wheat shows there is still interest in the weekly options. However, there is not as much interest in the WASDE catalyst on May 12 as there is in the Black Sea Agreement on May 18 as the biggest collection of open interest is out at the 24 days to expiration. 

Image 16: Open interest for next 30-day Wheat options

If I look at Corn futures, I draw a vertical line at each of the WASDE reports in 2023. While futures have largely been in a wide trading range, it seems to me that trend changes have tended to happen around these WASDE catalysts. 

Image 17: Daily Ichimoku Cloud Chart for generic front month corn with lines on previous WASDE reports

I have done the same for Wheat futures and there does not seem to be much of a change in direction, just a relentless downward pressure on the price of wheat. This may well be why many participants are not expressing views that WASDE will be a catalyst this time. However, we can also see that the market has gotten to an extremely oversold area, with the RSI (bottom panel) going below 25. When it has gotten this oversold in the recent past (i.e., November 2022, early March 2023) we have seen a bounce higher. Could a third time be a charm, especially if there is a catalyst no one is expecting?

Image 18: Daily Ichimoku Cloud Chart for generic front month Wheat futures with vertical lines drawn for the WASDE report dates

Putting this information together, I have come up with two trade ideas, one for corn and one for wheat. In both cases, I have used the flexibility of the weekly options, which allow traders to focus on specific catalysts. The growing volume and open interest in weekly options have given traders more tools in their toolkits to uniquely express specific ideas they may have. For corn, I want to lean into the fact that people are not focused on the upside, but WASDE reports have been a catalyst for a change in trend. I want to also take advantage of demand for options looking at the Black Sea Agreement date on May 18 and sell those as a way to fund my idea for the May 12 WASDE report. If I do this, I can sell one 620 strike call option expiring beyond May 18 and use the proceeds to buy 2,620 strike call options expiring the day of the report. This gives me leverage to the upside and leverage to the WASDE report. My risk is clearly that the May 12 catalyst is a non-event and these options expiring worthless, leaving me naked short a call expiring after the May 18 Black Sea Agreement. There is some hope that we may hear some news on this agreement even before the May 12 expiration, but if not, this is a risk I would need to manage. 

Image 19: Corn Weekly Options

For wheat, I am doing the opposite. I am selling options expiring around the WASDE report and buying options that expire after the Black Sea Agreement as I expect any news on Ukrainian grain to have a bigger impact on changing the direction on the relentless decline of Wheat futures than the WASDE report. I have used the skew in my favor to sell a 640 strike call expiring in the shorter time frame and using the proceeds to buy a 670 call expiring further out. The risk for me is that the futures move higher sooner, and I am then just short a 640-670 call spread. However, if nothing happens before May 12, and the 640 calls expire worthless, I am long a 670 call for the Black Sea Agreement for free. If I look at this spread in concert with the corn spread above, my risk here is a near term move higher in futures. However, the benefit on the corn side is a near term move higher in futures with extra leverage.  If nothing happens in either of the futures because of WASDE, I would be left short a corn call and long a wheat call for the Black Sea Agreement catalyst. A trader may not like that relative futures position, however, the Wheat futures are more oversold at this time.

I know there is a lot to think about in this week’s report. However, I wanted to show a few things. First being the major trends occurring in agriculture markets globally. Second, the potential near-term catalysts that could impact these trends and these consumers around the world. And lastly, how traders can use weekly options to uniquely express views around these catalysts.  I have shown ideas one could use if they think WASDE is a bigger deal than the Black Sea Agreement. I have also shown the opposite. I have finally shown how you can put two spreads together to achieve a relative value trade too. I hope there is something that everyone can use.

Importantly, CME Group has products that everyone can use to fine-tune their views and their portfolios. Good luck trading!

Image 20: Wheat Weekly Options

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