Soybean corrections offer opportunity

Futures, Jun 2008 by Cordier, James, Gross, Michael

Volatility is the buzzword for sellers of options on any market. Price volatility can create opportunities on both sides of the market and the investor who knows the underlying fundamentals will have the advantage in capitalizing on such volatility.

Soybeans have been on a wild ride as the spring planting season, weather events, exploding world demand and heavy fund interest have made the oilseed markets the place to be for volatility seekers.

While soybeans have benefited from the weak dollar and the commodity investing boom, like many agricultural commodities, their supply/demand fundamentals will carry more weight in price determination.

Demand: While the shift to biofuels has been a global phenomenon, in the United States, the primary product is ethanol. Asia, however, is partial to biodiesel, much of which uses palm oil as a primary ingredient. This new source of demand has created a shortage of palm oil and imported U.S. soybean oil is one way Asian nations are making use of a substitute product. A sharp increase in demand for high-protein soybean meal also has occurred as a result of the global wheat shortage. Use of soybeans to meet a growing global demand for food and energy produced record consumption of almost 240 million metric tons for the 2007/08 crop year.

Supply: Ending stocks measures the amount of product left in storage after all demand has been met at the end of the crop year. In 2007, U.S. farmers chose to shift more acreage to corn and wheat, cutting back soybean acreage to 63.6 million acres, the lowest more than a decade. As a result, 2007/08 U.S. soybean production fell to 2.585 billion bushels, with ending stocks falling to 140 million bushels, both the lowest since 2003. Along with speculator interest and a falling dollar, it drove soybean prices to $16 per bu. in February.

Fanners, of course, watch soybean prices closely and tend to plant the crop they feel will give them the highest profit. While corn and wheat prices have also soared, soybeans had outperformed through March.

The U.S. Department of Agriculture's (USDA) 2008 planting intentions report showed that U.S. fanners plan to increase soybean planted acreage substantially over 2007. U.S. growers projected planting 74.78 million acres of soybeans this year, up 18% over 2007.

This shift in acreage was larger than most analysts had expected and soybean prices plummeted on the report. Our view, however is that this sharp correction was, and still is, a gift to bulls looking for entry points.

Although current planting intentions would project larger ending stocks than last year, 224 million bu. would still make stocks relatively tight compared to 2005 (450 million bu.) and 2006 (550 million bu.). Also, global soybean consumption is expected to reach a new record in 2008.

And most importantly, with soybeans plummeting and corn surging in March due to a shift in acreage, it became more profitable for farmers to plant corn over soybeans. According to Purdue University, returns for planting corn are between $135 and $200 per acre more than soybeans. With this discrepancy, we expect farmers to have shifted soybean acreage back to corn as planting season began. While heavy rains in the Midwest hindered this shift, we continue to expect future USDA crop reports to show less soybean acreage than was originally projected in the March 31 report (see "On second thought"). This should support a case for soybeans trading above the April lows this summer.

Our strategy involves selling puts far beneath the current price to collect the premiums. As long as the futures price is anywhere above the option's strike price at expiration, the option expires worthless and the put seller keeps all the premium as profit. The investor profits if soybean prices increase. But the put seller also can profit if prices remain stagnant or even if our analysis is wrong and soybean prices decline further but remain above the option's strike price.

Current volatility has made put values enticing at strikes well beneath today's prices. Investors neutral to bullish beans can look to sell put premium several dollars below the current price. We favor strikes below the $8.40 level on the September contract. If soybeans remain anywhere above $8.40 through growing season, these puts will expire worthless. In the current environment of food and fuel shortages, that is a bet we're willing to take.

James Cordier and Michael Gross are portfolio managers. They are authors of the book "The Complete Guide to Option Selling" (McGraw-Hill 2005). They can be reached at www.OptionSellers.com, where they provide free tutorials.