2018 Soybeans: Lucrative Playground For Call Option Sellers?

Includes: SOYB
by: James Cordier

Regardless of Chinese and Argentine News Stories, The US Could be Facing a Soybean Supply Glut by Fall

Soybeans have attracted a bit of media spotlight as of late with speculation over potential retaliatory tarrifs on US soybeans.

This in response to the US recent tariffs on aluminum and steel.

China slapping a tariff on US soybeans would likely be bearish for prices, of course. However, Chinese tariffs are not the big story in beans - at least for option sellers.

Soybean prices will already face an uphill battle in 2018 based on massive US and global supplies coupled with a seasonal tendency for weakening prices into growing season. This will likely be creating a high probability environment for call sellers this spring - regardless of any action (or non-action) out of China.

That doesn't mean a Chinese tariff wouldn't have an effect for traders.

Chinese Tariffs - A Factor for Call Option Sellers?

A Chinese tariff on US beans makes US soybeans more expensive for Chinese buyers. Thus, it makes sense they would shift a large portion of their business to Brazil. This would hurt US soybean prices to some extent. How much remains unknown.

The US and Brazil compete for leadership in the global soybean market. A Chinese tariff on US beans would likely shift a share of US exports to Brazil and pressure prices in the US.

In our collaboration with CNBC's Jeff Daniels on their soybean feature last month, we said we thought it unlikely China would target US beans. That doesn't mean we wouldn't like to see our clients benefit from a drop in US prices should such a tariff occur.(To read the article and comments from our interview, go to OptionSellers.com/CNBCsoy.)

If or when China puts a tariff on US soybeans remains an unknown. As a seller of options, you shouldn't bet on unknowns. However, should you sell calls and China does tax US beans, it likely helps your trade. If they do not, it's almost certainly a non-factor. Thus, it becomes a "win win" situation for the call seller.

But why would you want to sell soybean calls in the first place?

That is the more important, and potentially more profitable question.

Massive Supply on Hand

The US will begin the new 2018/2019 crop year (September 1) with the highest ending stocks in a decade and the 2nd highest in over 30 years. Current US Ending Stocks were raised in last months USDA Supply Demand report to a whopping 555 million bushels, withstocks to usage ratio raised to 13.3%, the highest since 2006. This starts the 2018 crop year on bearish footing.

2017/18 US Ending Stocks will be the highest in over a decade and the second highest in 30 years.

…So Why Have Soybean prices been so strong in March?

Two reasons. One, the market is likely alreadybuilding a premium into the market ahead of US planting. Secondly, this rally is likely coming a little early in 2018 because of weather issues with the Argentine soybean crop. Dry weather has the market concerned that Argentine yields will shrink this year. Argentina produced roughly60 Million Metric Tones of soybeans in 2017. This year, because of yield reductions, that number will likely bereduced by a third.

But South America is near the end of its growing season and thusmost of these yield reductions are likely already priced into the market.

Considering that Argentine soybean production is only abouthalf of what the US or Brazil produces in a given year, a yield reduction there is not a game changer. A healthy crop in Brazil is expected to at least partially compensate for Argentine yield loss.

But that is not the biggest hurdle facing further gains in soybean prices.

2018 Crop Could be Game Changer in Soybeans

With the US beginning the2018/19 Crop year at near record supply, it will have a bigger safety net for any crop problems in 2018. However, US soybean planting acreage is estimated from 90-92 million acres in 2018. This means that the US should seeat least as many acres of soybeans as last year (90 million acres) and possibly more. (We'll have more clarification on this from the USDA's Planting Intentions report on March 29th.)

Granted, the US saw ideal growing conditions last year that produced an outsized yield. But with even an average yield per acre in 2018, the United States could see2018/19 ending stocks soar to over 700 million bushels - an all-time record.

Healthy 2017 US soybean yields produced the highest ending stocks in over a decade. With 2018 planting getting underway, 2018 soybean acreage is expected to be same or even higher than last year.

This is not a guaranteed scenario, of course. But with normal weather conditions, 2018/19 Ending Stocks are likely to beat least higher than this year. This would not only make any reduced Argentine yield look like a footnote, it would cast a bearish pall over the soybean market for the coming year.

If you're a call seller, this is very good news.

Conclusion and Strategy

While the potential for Chinese tariffs and Argentine weather are all the rage right now, the core fundamentals in soybeans paint a picture of a potential supply glut by the time the US crop goes to harvest.

The Argentine weather rally can be viewed as a gift to soybean call sellers focused on the bigger supply picture.

The USDA, in its latest supply/demand report, pegs average on farm price of soybeans in 2018 at 9.25 per bushel. Keep in mind, at the time of this writing, November soybean prices hover near 10.40 - largely the result of Argentine media coverage.

Planting intentions at or above 90 million acres in the US and a good start to planting season this month will likely bring an end to the Argentine story - not to mention the price rally.

Fundamentally focused option sellers can take advantage of the recent strength and look to sell theJanuary Soybean 13.00 calls at premiums of $500 or better.

January Soybeans

January Soybean 13.00 Call Strike

We'll be implementing a number of different strikes and strategies in the soybean market this month on behalf of our managed clients.

For those selling options on their own, the January callsexpire December 21st and should make a nice stocking stuffer barring any major weather issues. Margin requirement is approximately $1,150 per option - meaning a successful trade will bring a roughly 43% return on equity(although any trade involves risk.)

Of course, the Chinese could play Santa Claus and bring profits earlier with a US soybean tariff. That's a risk you'll have to take.

Happy planting season!