Report highlights

Traders that participate in one of the three Soybean markets may not be as familiar with related products. In this week's report Rich Excell analyzes the relationship between soybeans, meal and oil to identify correlated opportunities.

Image 1: Front month futures for soybeans, soybean meal, soybean oil and hypothetical soybean crush

Anyone involved in the soybean complex is likely familiar multiple elements of this chart. Whether one looks at soybeans, soybean oil, soybean meal or the soybean crush, all prices are at or near the lowest levels we have seen since 2020. In the case of the crush, we are at the lowest levels we have tended to get to over the last several years. Certainly, the bumper crop in Brazil and the discount of these beans to U.S. prices are not helping matters at all. However, one bright spot has been the increased demand for soybeans coming from renewable fuel. While U.S. export numbers have been trending lower the last several years, this domestic demand from a growing source could be a source of optimism. This week, I wanted to highlight the dynamics of the soybean market to some who may not be as familiar with much of the inner workings. This could create new opportunities for those who have only been focusing on one or two of these parts.

Image 2: Commitment of Traders report for soybeans, soybean meal and soybean oil

As seen in the charts, no matter which part of the bean complex you are looking at, the prices appear to be under pressure. It may not be surprising then to see that managed money is positioned short across all the products. This may not just be a matter of common sentiment in all the products. In fact, there is a more direct, mathematical, rationale for the correlation across the products. By virtue of the crush, there is a relationship that keeps the prices of soybeans, oil and meal all tied together.

Image 3: CME Institute for futures and options education resources

For more of the mechanics of the trade and how we get to the numbers in the chart above, I would encourage you to head to the CME Institute, where there are scores of videos and classes on a range of topics. A quick search for “soybean crush” brings us to a video where we can learn about what the crush is, why it exists, how it is calculated and how it is traded. Whether newbies or those looking for a refresher, it is a great resource that helps us set the table for how we want to consider possible trades in soybeans.

Image 4: Soybean crush price technical analysis

I can calculate the soybean crush and plot this spread price.  The actual position is 10 soybean contracts vs. 11 meal contracts and nine oil contracts. However, since it trades as a spread, but is delivered as a package, I can plot and analyze the crush price.

Above is a view on crush price from a technical perspective. Looking at the futures info tab within QuikStrike, I can look at where this spread price is in relation to both 50 day and 200 day moving averages. From the 200-day moving average, I can see that the trend is lower and has been for the last several months. However, if I look at the 50-day moving average, I think you may start to see a slight change occurring. The moving average itself is flattening out, suggesting the trend lower has begun to stall a bit in the short-term. In addition, crush prices are starting to probe above the 50-day moving average. While there have been a couple of false breakouts, if we were to get another move above, this could be the beginning of a counter trend move. Why is that important? Remember, managed money is short across all the soybean complex. 

Image 5: Cross correlation of soybeans, oil and meal

Using the CME Cross Correlation tool, I can see in the top chart that there is a positive correlation of the products to each other when looking in the daily log returns space. This tells me that the prices tend to move together, not directly one for one, but certainly a directional correlation. However, if I look at the implied volatility correlation, I see much lower correlations. My interpretation? While prices do in fact move with each other, options traders are not as focused on this bigger picture and looking solely at their own products, thus the option prices may not move together nearly as much as the futures do. For potential directional trades, this could present an opportunity.

Image 6: CVOL and Skew for all Soybean products

CME CVOL has a new feature that lets me choose a variety of products to compare against each other. In the upper chart, I look at CVOL over the past few years for soybeans, oil and meal. I can see there is loose correlation in the movement of the CVOL across products. Sometimes the levels move together, sometimes not as much. For example, last Fall I see soybeans flatline while CVOL for soybean meal moved much higher. Perhaps there was an opportunity here. In the lower chart, I look at the skew for each of the products. In this case, I see much more of a relationship as the skew levels – the difference between Up Variance and Down Variance – tends to move together. It is interesting to see skew for soybean oil moving higher, with potentially more demand for upside options than we see in beans or meal. Is this indicating a possible move in the other two?

Image 7: Volume and open interest for the Soybean products

In QuikStrike, I am also able to look at the volume and open interest for each of the contracts. In the month of February, there was a record in soybean weekly average daily volume. It was also the best February ever for Short-dated New Crop Soybean options. A lot more traders are using short-dated contracts to hedge new crop risk. Importantly, traders can see that there is liquidity in these contracts to fulfill their hedging and trading needs, perhaps more than they appreciated.

Image 8: Implied volatility by strike for oil, meal and soybeans

In QuikStrike, I have the functionality to look at implied volatility by strike for each of the products. In the top chart, I can see the higher demand for upside options, particularly for 49 and 50 strikes, in soybean oil. This matches the move higher I saw in skew from the CVOL tool. In the middle chart, I can see the demand starting to pick up for the upside in soybeans. However, the lower chart still shows very little demand for upside options in soybean meal. If these markets are correlated and there is a big, short position from managed money in all of them, is this an opportunity to look at upside in soybean meal? Perhaps for traders that have not considered Soybean Meal options before, maybe fearing there was not enough liquidity, this is the first time you might consider a trade in this contract.

Image 9: Expected return on a soybean meal, April short put spread vs. long calls

Putting this all together, I looked at the April contract for soybean meal. I wanted to get long upside but didn’t want to simply spend premium. However, I also appreciate that if this is someone’s first time trading the product, they may not want to have open-ended risk in selling options. Thus, I looked at selling a 335-320 put spread and then looked at what I could spend the premium on to give me leverage to moves higher in meal and a move higher in implied volatility in meal options. I was able to go slightly further out of the money and buy two of the 355 calls. This gives me leverage to a move higher in the futures, but also gives me long gamma and vega for the anticipated move higher in skew and implied volatility that may accompany a move higher in futures, knowing how short the market is, and knowing that this is a countertrend move that could be more volatile. There is a risk that on a continued move lower we could lose the difference between strikes on my put spread. However, this is a defined risk trade. 

There may be opportunities in adjacent markets that traders may have heard of but not be familiar with. I have seen growing options volume and open interest in a variety of products, and with CME Group tools at my disposal, I can potentially uncover these opportunities and find the best way to express a view. 

Good luck trading!

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