Think $5 Corn Is Expensive? Some Are Betting On $10 Next Year

Saturday, November 13, 2010
By Paul Martin

By Bruce Blythe

The corn market’s rally above $5 a bushel this fall has stirred growing consternation among livestock producers and others dependent on the largest U.S. crop. As the global grain supply outlook tightens, some traders in Chicago are placing bets that prices may double next year.

Over the past week, trading firms including JPMorgan Chase & Co. and MF Global Holdings Ltd. bought call option contracts that would pay off if corn rose above $10 or $11 a bushel next spring. The options are traded at Chicago-based CME Group, along with futures based on grain, cattle, hogs and other commodities.

It’s rare to see trading in so-called “strike” prices at such lofty levels, CME options traders say. The recent trading reflects heightened concern that smaller-than-expected U.S. crops and increasing demand from top buyers such as China will force grain prices even higher in 2011, said Ed Van, a broker in the CME’s corn options pit.

“There’s real risk out there” for higher prices, Van said. He’s been trading in the corn options pit since the contract was launched in 1985 and said he’d never seen an $11 call traded until the past week. “Price rationing could take it up further. I would certainly think we’re headed higher.”

Concern over tight supplies also spilled into the soybean market, where $20 call options traded over the past week, a premium of more than 50 percent over current futures prices.

In trading today, December corn futures fell 2 ¾ cents to $5.64 a bushel, still up 59 percent since the middle of the year. November soybeans rose 20 ½ cents to $13.30 ¼ a bushel, the highest closing price since September 2008.

Buying a call option grants the right, but not the obligation, to buy an asset at a set price in the future. While there are myriad futures and options combinations, owning a call is by itself typically a bullish position, with the buyer betting that the price of the underlying asset will rise above the strike and the option can be exercised at a profit.

Corn at $10 is an extreme scenario and it’s unlikely prices will climb that high, many traders and analysts say. Even with this year’s rally, corn is still below a mid-2008 peak of $7.65, the highest since corn futures began trading in Chicago in 1877.

Still, the recent options trading underscores intensifying market skittishness over potential shortfalls in coming years as importers, ethanol producers and livestock feeders compete for dwindling global grain supplies. Earlier this week, the U.S. Department of Agriculture cut its estimate for the nation’s corn harvest for the third time in as many months and said domestic stocks of the grain in 2011 will sink to a 15-year low.

The fact that someone bet on the prospect of $10 corn is by itself jarring, said Steve Meyer, a livestock analyst who runs Adel, Ia.-based Paragon Economics. Corn prices above $10 would generate substantial losses for beef and pork producers, no doubt spurring herd reductions much more severe than what followed corn’s spike in 2008, he said.

Consumers, who are already paying record supermarket prices for bacon, would face even higher meat costs as animal inventories decline, he said.

“It’s kind of a chilling thought,” Meyer said today, referring to $10 corn. “You’re talking devastating kinds of costs” for livestock producers, he said. “You’d see liquidation on a massive scale in the pork industry, and in chicken, turkey and beef as well. It would decimate all of us.”

As of the close of trading yesterday, there were 850 open contracts in March 2011 $10 corn call options and 1,286 positions in May 2011 $11 calls, according to CME reports. In soybean options, there were 1,686 positions open in March 2011 $20 calls.

It wasn’t known who specifically owns those calls, though trading floor sources said speculators probably account for many of the positions. JPMorgan and MF Global are among many firms that process orders in the CME agricultural markets on behalf of outside customers. A JPMorgan spokeswoman declined to comment.

The $10 and $11 calls account for only a small fraction of total options trading, traders noted, and corn futures have eased from a two-year high of $6.05 reached earlier this week. Still, traders are bracing for potentially explosive upside market activity as 2011 approaches.

“Once we get into the new year, I wouldn’t be surprised to see $11, $12 and $13 calls trade,” said Matt Connelly, an independent corn options broker at CME. “There’s not enough acres in the world for the demand China is throwing at us.”

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