Target Big Premiums In February With The 'Minnesota Squeeze'

Includes: SOYB, WEAT, WEET
by: James Cordier

Old School Farmer Secret can pay big dividends for modern day option sellers

If you're looking to get diversified into something uncorrelated to the equities market, you can't get much further away than the US grain markets.

I love trading grains. Unlike stocks, there are no earnings to watch or rate hikes to worry about. There is much less "public interest" swaying grain prices with the headlines of the daily paper.

Here it's old-school farmer stuff. How much is in the barn and how much are they ordering? Grains benefit from very precise and measurable supply and demand figures, making them amenable to fundamental analysis.

US Winter Wheat Crop

The US winter wheat crop begins to sprout in January.

Winter can be a stable time to sell options in grains. Why? Because here in the US, crops are in the silo, almost nothing is growing, there are no weather concerns to worry about. Only the normal, measurable flow of supply and demand.

Which makes seasonal tendencies very attractive for them in winter.

You're not getting a trade for one market this month, but two. Because trading two related commodities at once can offer you not only great yields, but an extra layer of protection. It's how professionals sell options to give themselves an extra edge. But you'll rarely read about this kind of option selling in a book. You will get a peak behind this curtain today, here.

What you'll see here today is a strategy we've termed the "Minnesota Squeeze." And when you watch or read us talking about "balancing" a portfolio, with positions offsetting other positions, this is the kind of advanced strategy we're talking about.

Winter: Time to Grow Wheat

It is true that almost nothing is growing in the US winter. Almost nothing. The US winter wheat crop typically sprouts in January and grows through the Spring. Wheat is actually a form of grass and you can grow it just about anywhere, even in the freeze of winter. In fact, nearly 75% of US wheat production is winter wheat (also known as "white" wheat.) Thus, although wheat can often share related price patterns with its cousins, corn, soybeans and oats, its seasonal tendencies can differ widely, due to different harvest times.

How can you potentially make money from this? By taking advantage of the discrepancy in seasonal patterns this time of year.

Wheat prices, as you can see in the chart below, have historically tended to decline in the winter and spring months. Although winter weather can indeed be harsh, there is no dry heat. Dry heat is the biggest danger to summer crops. Instead, winter wheat tends to grow predictably through its June harvest time. Thus, unlike soybean prices, which tend to begin declining after the crop is "made," any anxiety in wheat prices tends to start receding once the crop sprouts.

July Wheat

Wheat prices have historically tended to decline into spring as the winter wheat crop emerges from dormancy.

Winter: Peak Demand Season for Soybeans

Meanwhile, over in the soybean market, a different set of fundamentals is unfolding. US harvest is far behind the market but spring planting is still well ahead. Brazilian soybeans will not be widely available until at least May.

But demand for soymeal surges in the winter. Cattle, pork and chicken farmers in the US, Japan, China and elsewhere are forced to move their animals out of pasture and off of grass-based food and rely on soymeal as a primary food source. In addition, animals can consume more calories in the winter as colder temperatures require them to burn more for heat.

Out of the pasture and into the feedlot. Cattle producers must rely more heavily on soymeal as a food source during winter months, spurring soybean demand.

This spike in demand is notable and has historically helped spur soybean prices from winter into spring - as illustrated in the seasonal average price chart below.

July Soybean

Soybean prices have historically tended to rise in winter as demand for Soymeal as animal feed soars during colder months.

While wheat and soybean supplies both remain healthy at this time, it is worthy of note that seasonal price moves have tended to occur regardless of outright supply or demand at any given time. Does that mean it's guaranteed to happen this year? Of course not. But without any foreseeable "abnormalities" in either market at this time, we see it as a good bet.

So how do you monetize this discrepancy?

The Minnesota Squeeze

The old farmer play for this seasonal is to sell the wheat futures contract and buy the soybeans futures contract and play the "spread" between the two. But that is a hedge-like strategy that we won't get into here. Why?

  1. Because as an individual investor simply seeking diversified yield, you need not concern yourself with vehicles such as futures contracts and
  2. Because there is a better strategy that can offer you even higher odds of profit than doing it the old "farmer" way

We call it the Minnesota Squeeze.

Deploying the Minnesota Squeeze

You can implement the Minnesota Squeeze this month by

a. a.Selling a call option far above the wheat market
b.Selling a put option far below the soybean market

What does this do for you?

  1. It allows you to profit if soybean prices rise
  2. It allows you to profit if wheat prices decline

Of course, the farmers will profit if that happens too. But by selling the options this way, you gain an extra advantage: You can profit even if soybean prices don't rise and wheat prices don't fall. Soybean prices don't have to fall - they only have to stay above your strike. Wheat prices don't have to fall, they only have to stay below your call strike.

That's an enormous advantage the farmer doesn't have.

But you have one final advantage that really puts the Minnesota Squeeze over the top. Soybean and Wheat prices don't move in tandem. But they do share some related fundamentals whose alteration can affect both markets the same way. By selling options this way, you effectively create an inter-commodity strangle - and gain all the benefits that come with an option strangle.

Most important of these is, if a factor comes along that affects both markets (think Russian Grain embargo, China trade tariff) you have one position effectively balancing the other - at least to a certain point.

This means a more stable trade and additional layer of insulation against loss. In other words, if both markets move in tandem (which is unlikely but possible), at least one of your positions will be profiting, somewhat balancing the loss on the other.

In a grain bull market, beans should outperform wheat. In a bear market, wheat should fall faster than beans. The squeeze can potentially profit in both scenario.

The Minnesota Squeeze isn't ironclad. A runaway bull market in soybeans or an outright collapse in wheat prices could make a loser out of one side of the trade. There is no such thing as a silver bullet in investing. But the Minnesota squeeze can offer particularly high odds of success if implemented properly this time of year.

Strategy Suggestion

We've been positioning our managed clients in our private version of the Minnesota Squeeze for the last 2 weeks (yes, you can also add a credit spread feature to this trade - providing yet another layer of protection and probabilities.)

If you're not yet a client and want to take advantage of such a trade, we suggest considering selling the July Soybean 9.00 put on pullbacks (target premium $500, Margin req. 870) and the July Wheat 5.40 call on rallies (target premium $550, Margin req $950). Entry points for taking this premium should be available from now through February.

July 2017 Wheat

Selling the July Wheat 5.40 call

July 2017 Soybeans

Selling the July Soybean 9.00 put

By the way, there are several states that grow both soybeans and wheat. But Minnesota had a certain ring to it.

If extra protection, high yield and attractive probabilities ring for you, this is the month to take your trade to Minnesota.

Happy Squeezing!