The soybean market is dominated by two major producers: Brazil and the United States. Soybeans are harvested in November-December in the U.S., while the Brazil harvest takes place in May-June.
While most of the U.S. crop is sold soon after harvest, which crushes prices at that time, certain quantities are kept until the early spring in hopes of receiving higher prices. By early spring, as U.S. farmers need to raise cash for the spring planting, most of the remaining storage capacities are sold at the market, pushing the price to its lowest trough of the annual cycle. At this point, stored soybeans are at their minimum levels for the entire year, while the Brazilian harvest will remain on the fields for another 3-4 months and will not reach the markets until June-July.
The price begins to rise and it will not reach a peak until Brazilian soybeans hit the global market in mid-summer. This seasonal pattern is known as "February break," as the low usually happens during the second month of the year. It has been pretty reliable, as the 37-year seasonal chart below clearly shows.
Is this year ripe for trading the soybeans seasonal pattern, or is it a deviation? I believe the market is setting up for a great seasonal trade from the long side. Higher prices in the fall lead to an above-average portion of the U.S. harvest being sold immediately. High prices remained into early January 2010 (see chart below), and most of the remaining storage was sold early, pushing the prices down to what looks like the annual low in the middle of February.
Although the fall harvest was robust, record global and domestic U.S. demand devoured the supply, and the remaining storage at present is at the low end of the range, compared to levels on the same date in previous years. U.S. soybean exports through Feb. 4 were 978 million bushels, compared to last year’s 716 million. As the remaining U.S. soybean storage is nearly depleted, the prices have already started to climb.
True to seasonal tendencies proven over many years, the rally should continue to trend higher, making its ultimate peak in June-July before Brazil's harvest becomes available for export. However, traders should not go for home runs here, as a record harvest is expected in Brazil due to ideal growing conditions. But as the record supply hitting markets in late summer is already priced in, any adverse weather surprises will likely cause sharp price spikes, which provide a great opportunity to take some or all profits out of this trade.
Click to enlarge
I suggest two ways to trade this seasonal pattern. One vehicle involves buying the May or July futures. While the May contracts will not see the price highs due to the near completely depleted soybean storage in June-July, it also will not experience the scary volatility of the July contract right before expiration, as some early Brazil supplies start to be offered for delivery. I would advise the small specs, which are not as well capitalized as institutional traders and hedge funds, to stick with the calmer May contract.
Options on the above-mentioned contracts also may provide great returns in the soybeans trade. Buying the calls is potentially the most profitable strategy, albeit a very speculative one despite the solid soybean price fundamentals. A two- or three-day correction, such as the one this week, can easily wipe out your entire investment.
Unless your entry point is especially well-timed and you are very good at timing the market, I would recommend some hedging or buying calls that are deep in the money. As I am writing this on Feb. 19, the May contract is trading at 954, while the 820 May call ask price is 130. With only $6 out of the $130 being time value, a buyer of this call will not have to worry about time erosion of the option. While a trader will likely not double his investment with this option, any corrections will cause a mere 10-20% drawdown as opposed to 50-100% with a call strike which is at or near the current price.
Traders can decrease their cost basis by writing some naked puts below the low set this month of approximately 920, and/or naked calls way above the market at around the 1300 level, as these options are almost certain to expire worthless.
Disclosure: The author has no current positions in the futures and options contracts mentioned above.