There’s a fairly reliable seasonal tendency for soybean oil futures to trade lower from November 20th through December 18th. This is a simple and direct way to approach the market with one major exception; soybean oil is currently in a strong uptrend.

WHY BOTHER?

The legitimate response to the above paragraph is; why bother trading soybean oil against the trend? The answer to this question is; potential sizable profits. Indeed, if soybean oil, which appears to be in a very strong uptrend is, instead, at the top end of a very large trade range, substantial profits could be achieved if prices begin working down toward the low end of the range. My advice to clients looking to trade against the trend is to utilize options rather than trading futures.

SOYBEAN COMPLEX

The USDA issued a monthly supply/demand report on November 10th. The report indicated that U.S. producers were in the process of harvesting a record large soybean crop. Harvest is currently 90% complete. The USDA figures further indicated there will be a substantial increase in projected soybean ending stocks. Finally, mostly due to an outlook for large soybean production in South America, the USDA has increased projections for world soybean ending stocks, as well. Since this report was issued on the morning of November 10th, soybean futures for January delivery have rallied 77 cents. The obvious conclusion is that soybean demand must be strong or improving…or is it?

It appears the grain markets have enjoyed a massive influx of speculative money. The sources of the money appear to be index funds, trend following funds and small, medium and large individual speculators. The driving force behind such speculation appears to be the declining dollar, near zero interest rates in the U.S. and the dramatic leverage and liquidity which soybean futures offer to all traders. It’s my opinion the impressive rally has reached well beyond any fundamental logic and that, eventually, soybean prices will decline in line with fundamental forces.

Let’s take a closer look at the fundamental landscape. First; much uncertainty has been removed regarding the size of the U.S. crop. The USDA has pegged the crop at just over 3.3 billion bushels, which represents a record large crop. With harvest more than 90% complete, it’s doubtful the size of the crop will change much. Second; projected ending stocks were pegged at 270 million bushels, up dramatically from last year’s very tight stock levels of 138 million. Third; projections for soybean production in South America are looking good with their crops likely to be substantially larger than last year. The outlook for increased production in South America contributed to the rising world ending stock projections.

SEASONAL TENDENCY

There’s a strong seasonal tendency for soybean oil futures to trade lower from the period between November 20th to December 18th. Currently the January soybean oil contract is trading near the highs established last June. This was at the start of the growing season, before we knew the acres devoted to soybean production, let alone the yield and large crop size. As stated above, this information is known at this point and the size of the crop is not likely to change much in the near future. Thus, we have far fewer unknowns for the market to grapple with. Removing a major unknown from the market vastly increases the likelihood of a trading range market until there’s real proof of a substantial increase in demand for soybeans, beyond that of the fund manager and speculator.

My rule of thumb when looking at a seasonal trade that is against the current trend is to position with options rather than futures. I this case, I’m recommending the purchase of the January soybean oil 39 cent puts at 100 points or lower. January soybean oil options expire on December 24, or only 35 days to expiration. There’s enough time for the seasonal to play out but not much. Thus, you have to be close to the money when you establish the position. Furthermore, I recommend risking only 50 points on the put option rather than the total purchase price. Soybean oil options give you the right to be either long or short one soybean oil contract, or 60,000 lbs of soybean oil. Each point represents $6, thus, purchasing the 39 cent put for 100 points represents a $600 premium outlay per option. Risking 50 points represents roughly a $300 risk, depending on exactly the exit price. I have two downside targets in mind for the seasonal play. The first target is 3750 with a final target at 3630.

If you’re not currently satisfied with your brokerage relationship, I invite you to give me a call or send me an email to dennis.smith@archerfinancials.com or 1.877.377.7905.

Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. The views and opinions expressed in this letter are those of the author and do not reflect the views of ADM Investor Services, Inc. or its staff.  The information provided is designed to assist in your analysis and evaluation of the futures and options markets.  However, any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to ADMIS. Copyright © ADM Investor Services, Inc.