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Corn! For Smart Options Traders, It's What's for Dinner

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A unique opportunity is popping up in the corn market.

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This article is a sample alert from Steve Smith's OptionSmith subscription service. Take a free trial and get the trades that have put Steve up 11% year-to-date after a 43% gain in 2013.

On Monday (subscription required), I mentioned I was interested in establishing a bullish position in corn using the Teucrium Corn Fund (NYSEARCA:CORN) as the vehicle.

I'm getting a toehold and making an initial purchase of some calls:

  • Bought to open 15 August $35 calls (CORN1400816C0035000) at $1.60 a contract

These can be illiquid at times, but there is actually some decent volume in these later-dated calls, which presents an opportunity.

The dynamics are in place for a substantial bull move in corn this summer. While the first official USDA crop report for acres planted won't be reported until mid-May, the initial numbers being floated suggest only a modest increase for corn. The more important determinants will be the yield and demand. 

Yield-per-acre on most crops, particularly corn, peaked in 2007 at about 11 metric tons per hectare. In 2013 that was down to 9.7 tons. It seems the world has pretty much reached the limit of what genetically modified seeds and fertilizers can do to boost production. 

Feeding into this is the fact that farmable land might actually be shrinking. This seems to be especially true for China, which has seen both yield and acreage decline over the past three years. China may become increasingly dependent on Russia for foodstuffs. But Russia is better equipped at supplying wheat than corn. Either way, the political fault lines currently being drawn across Europe and Asia can only lead to tension.

This leads us to the demand side of the equation. Most corn is used for feedstock, so demand for animal protein creates demand for grains like corn. China and India remain the largest importers of grains despite attempts to become more self-reliant. Part of their inability to keep pace with demand is driven by the emerging-market phenomena of growing middle classes making beef and pork proteins bigger parts of their diets. 

There is not one case in history where that trend has been shown to reverse itself.

Who knows -- maybe the locavore movement, Whole Foods Market (NASDAQ:WFM), and Chipotle (NYSE:CMG), which all push grass-fed meats, can upend that here in the US. But that's beyond the scope of this discussion.

We have already seen an increase in beef prices of late, which was part of the residual impact from the 2012 drought. Also, the surge in grain prices was strong enough that beef and pork producers found it unprofitable to feed expanding herds, which increased production activity. That led to the steep declines we saw in 2013. We are now back to finding an equilibrium with solid underlying demand.

Even the lower-quality feed corn is a fairly sensitive plant that needs the right conditions at the right time for proper growth. By comparison, soybeans are essentially a domesticated weed and can survive a variety of stresses.  

The first test will be getting the plants in the ground, which begins in May. I'm not going to say that this interminable winter will linger until then, but if there is another snow event and temperatures stay persistently cold for the next few weeks, this could lead to overly soggy ground that delays some plantings. 

The real crucial part comes around late June when corn enters the detasseling stage (a key phase in the growing cycle), which is what will determine yield. Too much or too little rain will stunt the growth and prevent kernels from forming.

Some 25 years ago I worked the grain pits on the Chicago Board of Trade, and I've never seen a summer pass without at least one weather scare. Today we live in a world of heightened speculation, and there is an underpinning of increased demand, so the pieces seem in place for a good summer rally. I'm getting my first mustard seeds in the ground with these call options.

Twitter: @steve13smith

This article is a sample alert from Steve Smith's OptionSmith subscription service. Take a free trial and get the trades that has Steve up 11% year-to-date after a 43% gain in 2013.
 

Position in CORN options.

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