A Corn Options Trading Method & The Problems With Options - Fred Montgomery
This analysis involves a trading method involving Corn Spreads. The trade buys Sept Puts 15¢ out-of-the-money and simultaneously buys Sept Calls, also 15¢ out-of-the-money, The idea being a big up-move caused by weather concerns during June/July would make the calls skyrocket. Conversely, if no big up- move the puts would go up in value as market drops. In addition, if the trade does not double its total investment by July 4, it's recommended the calls be dumped and puts be doubled-up, as the market is very likely to drop if no big up-move takes place by July 4. This year I executed this trade during the recommended time frame (on June 4) with Sept Corn contract being priced at 275 at the time.
Though I have this commodity option (spread) trade underway now, I must confess I never really liked trading options. Some years ago I traded them more frequently than now and usually never made money (or lost money) using options.
My biggest complaint with all options is that if the price goes in your favor, they usually add to the option value at a much smaller percentage than how much they take away from it when it goes against you. It's always less you make when going your way, and more you lose when going against you.
For example, Friday, June 9, Corn closed down 2¢ vs. Thursday. However, they only added ¼¢ to the out-of-the-money 260 Put, going from 5-½ to 5-¾. However, they took away ¾¢ from equally out-of-the-money 290 Call, going from 10-½ to 9-¾.
In other words, my long put gained ¼¢, but my long call lost ¾¢. My loss for just one typical day was triple my gain in percentage terms. I Have seen that occur often, both on this trade and other options in other markets over the years, including a number of spread trades. In fact, I have seen many more extreme examples.
After looking at the facts, I now believe it will be very difficult to double my money on this spread. For example, the 260 call was 21-½ on Friday, with the call being 16¢ in the money. That means if Sep. Corn went to $3 .06 it would then result in the 290 call being 16¢ in the money, and it may be worth about 21-½ or so.
However, it would likely be worth less than that because of time decay between now and the potential $3.06 price. Speaking of time decay, I recall some trades where the market was flat or even went my way to a degree, but I still lost money as they took away the time premium every day, making my option worth less, even if going my way!
The put is similar to the call scenario. For example, the 270 put is now out-of-the-money by 6¢, and worth 10-½ as of Friday 6-9. For my 260 put to double, which I paid 5-7/8 for a week earlier, the price would have to drop an estimated 8¢ in the money, or a price of about $2.52 or so. An even lower price would be necessary due to more time premium decay, if the move took a while to take place.
These Sept. Options expire on 8-18-95 according to my broker. That means there's only a short amount of time for the price to make a huge move either down to the $2.52 area for the put to double, or up to the $3.06 area for the call to double.
Moves of that magnitude in corn seem highly unlikely. For example, even with all the unusual major news stories recently, such as flooding, late crops, Russian sales, other exports, etc., the price only moved about ½¢ today.
Keep in mind, even if the price does make a big move and the option doubles, what about the loss on the other end! If the price goes up to $3.06 or so the 260 and 250 puts would be almost worthless. The opposite is true with the calls being almost worthless if the price drops to $2.50 area.
If the price makes that huge move up or down and we double the value, it may only be a break even because almost the entire investment on the other end would be a wipe out. If that's true, it seems to me we would actually have to quadruple our profit on the winning end to in reality "double our money!" By the way, what with daily time decay, the scenario on this trade is even worse than my above calculations, with even a bigger move required, either below $2.50 or above $3.10 for the 260/290 options.
Note: We operate open member forums and
consequently reserve the right to publish some public type of communications
received. Please indicate "confidential" or
"not-for-publication" on any correspondence sent us
which you want kept private. Thank you.
Copyright by Webtrading.com - All
Rights Reserved. Webtrading/CTCN. For comments about CTCN Home
Page design or connectivity, please contact our
Webmaster. This page is maintained by
Webtrading Internet
Services.
