Wow, interesting day! The FOMC Meeting press conference yesterday included some discussion on tightening their monetary policy in maybe 2023 (it's currently 6/17/2021; ya gotta be kidding me), and look what happened today. Risk off in most assets. The Federal Reserve is in a roach motel, in a box, that's painted in the corner, inside the Hotel California. In other words, they're stuck with either extreme easy monetary policy, or crashing the markets.
Regarding our Corn trade, first thing to say is our Stop was hit on Wheat. So we're out of July Wheat. For more details, see:
https://jmstweets.blogspot.com/2021/06/wheat-might-make-some-bread-exit.html
After Wheat got whacked for $-552.50, I had to decide whether to also exit Corn and/or the hedge. Corn ended the day at $-576 and the ZW July 660 Put hedge ended the day at $+698. While the hedge more than covered the incremental loss from yesterday, it hardly covers the combined loss of Wheat and Corn, which is about $1,100. So, what to do?
Well, we need to decide whether Corn is going up or down from here, and since the hedge is actually on Wheat, we need to decide on where Wheat is going from here also.
If you go to the link above and see the Wheat chart, you'll see it broke out of the downward Flag channel its been in for about 12 days. It broke to the downside, which was unexpected. It made a slight new swing low. The previous low was 639 1/2 and today's low was 637 1/4. Does this suggest further downside or a double bottom?
I see a possibility for both. Notice the 200sma exactly coincides with the 78.6% Fib of the green range at about 630. Notice also that Stochastics are just about to go oversold. It seems likely that when the market opens up, price can go further down, or gap down, to this 630 level, then reverse and head back up. If this is a Double Bottom pattern, then we're headed much higher.
Another way to look at this is that we've formed a "lower case 'h' " pattern on the Daily chart, after forming a Double Top. This is going back to about April 27th. If this is the "Dreaded 'h'" pattern, or it also qualifies as an "Inverse J-Hook" pattern, then we're going much further down.
So, which is it? There's no way to know before the market closes on us today.
I'll tell you my thinking, but first you need to understand what option Delta means. The Delta value of an option tells you how much the option price will move as a function of a move in the underlying security. Delta is the percentage of the underlying that the option price will move . For example, when we bought the July Wheat 660 Put, the Delta was .514, which I documented in the post that day. That means for each point that the Wheat Futures contract moved downward, the option price would increase by .514 points.
You also need to know that the Delta value is not constant. As the underlying causes the option to move more in the money, the higher the Delta becomes, up to a maximum of 1.0. And the opposite is true. As the underlying price action causes the option to move more out of the money, the lower the Delta becomes, down to a minimum of zero. The amount the Delta value moves relative to the amount the underlying moves is called Gamma, but we can skip that for now.
I bring up Delta because if Wheat goes down further then Delta will increase. In fact, its already increased substantially because the underlying Wheat Futures has dropped considerably since we got the option. Today the option's Delta was .71 at the market Close, up from .514 when we got the option. So now the hedge is increasing by about 70% of the move in the futures rather than about 50%. This is an important consideration in the decision of how to handle the situation we find ourselves in.
Keep in mind that Wheat and Corn have been moving very similarly since this trade began. I expect this to continue for the duration of the trade. So, if Corn reverses and heads back up, I'd expect Wheat to go up as well.
OK, let's look at the Corn chart above. I see a reason to bounce and a reason to continue downward.
See the 2 thin white horizontal lines? We closed right at the same level today. Those lines represent support/resistance levels from late April and mid-May. Look on your 4 hour chart to see them better. We may bounce off these and head back up. Just under those lines, there's a possible Trend Line, the 50% Fibonacci level, the bottom Bollinger Band, and the bottom of the Keltner Channel. These could also provide support. Also, very often when there's a big move on a given day, the next day sees a retracement.
On the other hand, we've made a lower swing high on 6/10/21 vs 5/7/21. That's Bearish. We've been below the 8ema for 4 days. During those 4 days, we've formed a Bearish Engulfing pattern twice. And the Bollinger Bands have been inside the Keltner Channel. Just a little inside, but if those Bollinger Bands flare apart then we may have a release of a BB/KC Squeeze, which would mean Wheat will go down much further. And, Stochastics are still in the mid-range, giving the downside lots of runway.
Bottom line, which way do we think Wheat and Corn will break tomorrow, up or down? Bottom line, we don't know.
Here's my thinking. If we get a bounce, and price heads higher, we'll hold our position until the hedge profit goes to zero, then sell it. We'll break even on the hedge. By the time that happens, the Corn futures contract will have recovered much of its value. The loss at that point will be much more tolerable, and maybe we'll have an indication whether Corn will continue higher or not.
If price heads lower, then the value of the hedge will increase faster than the loss in the Corn Futures contract. Why? Because remember the option is on the ZW $50/pt contract while the YC Corn Futures is $10/pt. The option Delta will be at least 75% and .75 x $50/pt = $37.50/pt for each $10/pt move in Corn. In fact, if Corn and Wheat fall far enough, the hedge should recover all the loss in both the Wheat and the Corn Futures.
Given our current position, if price goes up, we reduce our loss. If price plummets, we could eliminate our loss completely. So, my final decision was to hold both the Corn Futures and the hedge.
If you are asking why not sell the Corn now, its because it may go up from here. If I thought Corn would just go flat from here until expiration then I'd sell both the Futures and the Option. But I think sideways price action until expiration, while possible, is unlikely.
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