The Farmer's Dream is Beans in the Teens

- Richard Jones

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September 19, 2007

I wrote a bullish article on Nov. Soybeans back on 2/28/07. It was based on 2/23/07 closing prices. It was for traders that trade at least 10 lot minimums. That “cash-free” trade excluded commissions and fees and the figures used did not account for slippage on the fills. Commissions and fees vary considerably based on the brokerage house used. Using the CME's span software program based on 2/23/07 closing prices, the initial margin on this 10 lot futures trade was $13,000 with a best-case profit potential of $185,000!

It's now 9/17/07 and 7 months have passed since I wrote that article. Let’s review and update the trade based on 9/17/07 closing prices.

Below are the components of the trade with a review, update and comments:

Bought 10 Nov. Futures @ 8.30 (every 1 cent up from 8.30=$500)

Review: Buying futures means you were a market bull and were looking for the bull to run to new highs based on a forecast of a big drop in planted acres which should be allocated to corn plantings. If that happened and we found out when the 3/30 prospective plantings report was issued and was very bullish as expected, you may have to buckle your seat belts for a historical bull run to new all-time highs in new crop Nov. soybeans.

Update: Futures are now at 9.69 and you are in profit city $1.39 x $5000 = $69,500. The report came out and was bullish as expected. That's what you call a beautiful bull run, and that is why we speculated in commodities in the first place. Will the bull continue to run? As of today it sure looks like it.

Bought 10 Nov. 8.20 puts @ 56 cents each

Review: For this type of trade, it was a good idea not to have naked futures. Buying these puts was a hedge against the long futures contracts. On the expiration date of the options, your maximum risk on the futures position is $500 each. I believe strongly that buying options is a far superior way to position trade rather then using stops in futures and getting stopped out of the futures position constantly, thereby missing a move in your favor. This is a particularly true for a long-term position trade. Buying these puts are based on the same concept of buying insurance on a house or a car every year; you assume you never need it, but it is there when you need it and that's why you brought it in the first place -- as insurance.

Update: The value of the puts is now 3 cents. That's Okay because the cost of these puts came out of the market and you want them to expire worthless because that means you got a winning trade in the futures position!

Sold Nov. 7.80/6.80 put credit spreads @ 28 cents each

Review: To make this a “cash-free” trade, we had to raise 56 cents to pay for the cost of the puts. We took the cash out of the markets by first selling these put spreads and raised 50% of what we needed. The benefit of the credit spreads is that it created limited risk and because they were 51 cents out of the money. They had a reduced margin. In addition, you were selling over-valued option premium. The risk on the put spreads is $5000 each, so if the market sells off and gets close to your short strike price, you will have to go on defense by using the CME's span software program. Some examples of reducing downside risk would be to buy 760/740 put spreads or roll up your long 680 puts into 720 puts would be two things you could do. There are other adjustments you could also do, buy hey, let's be positive since we are very bullish!

Update: As of 9/17 those puts credit spreads closed at 5/8 cents which equals a 27 cent profit or almost a 100% winner. You may buy back these credit spreads and get rid of any downside risk. The short 780 put strike price is now $1.89 out of the money instead of 51 cents when we first started.

Sold 50 12.00 calls @ 6 cents each

Review: After selling these calls, we had raised 58 cents that covered the 56 cent needed for the 8.20 puts that made the trade “cash-free”. By selling the calls, we were doing a ratio write of a 1 x 5 (long 1 futures which covered 5 out of the money calls) Why we desired to sell these calls were because they were $3.70 out of the money, plus they were extremely over-valued. The final reason to sell these calls was that it reduced the risk of selling the put credit spreads because it is impossible to lose on both sides at the same time. Your futures profit zone is from 8.30 (futures entry point) up to $12.00 (short call striking price) which equals 12.00-8.30=3.70 x $5000=$18,500 x 10 lots = $185,000!

Update: These short calls closed at 1.1 cents and are in profits! That shows you how 7 months of time decay works and that's why you desire to sell over-valued out of the money options!

Summary review: With a profit zone of $3.70 in new crop Nov. Soybeans, this trade should work out fine as long as beans do not collapse big time below $7.80 or explode much above $12.00. I recommended taking the risk with a $3.70 profit zone! What looked great was your potential rate of return. If the trade yields the maximum profit of $185,000 on an initial margin of only $13,000, your potential rate of return on your margin dollars is over 1000% and it was a “cash-free” trade using the “markets money”!

Update: If I loved the trade on 2/28 and the market is now at $9.69, I love it more now. The trade looks like it will be a very big winner!

With a degree in Accounting and an MBA in Management, Richard Jones worked his way up the corporate ladder to become an Assistant controller of Ticketron in N.Y.C. In 1981, he changed his career and became a broker. He worked for several retail option trading firms where he specialized in selling options and using his "cash-free trading" approach to the markets.

In March 2004, Richard opened Distinctive Trading and currently clears through P.F.G. as a G.I.B. He trades all markets but prefers to trade "using the market's money" to cover his trading outlays using a strategy that combines futures and selling more options than you buy.

In May 2002, Futures magazine published his article "Trading with the market's money". One of Richard's forte is getting out of margin calls using CME span software program.

In last year's PFG's CTA Traders Challenge, Richard earned his client a rate of return of 22% in the first quarter and 12% in the 2nd quarter.

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Cash-free trading doesn't mean cashless, but it is possible to use other people's money to cover your trading outlays while predetermining your risk, using a strategy that combines futures and selling options. Richard Jones outlines a strategy to execute cash-free trading and illustrates it with real world, detailed examples great for any level of trader. Get your complimentary article today.