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Put buyers bet CBOT wheat’s strength won’t last

The U.S. Department of Agriculture has dropped its demand assessment by 30 million bushels

Reuters — Chicago wheat prices may have rallied more than 10 per cent since October 1, but judging by a jump in bearish put option positions tied to the March delivery slot, they are likely to turn lower going into the New Year.

More than 3,600 put options were bought at the $4.80, $4.90 and $5.00 March strikes since October 15, just as March futures climbed from around $5.20 to above $5.40 and six-week highs. Concerns about the diminishing competitiveness of U.S. wheat versus other international origins, as well as against corn in the domestic feed market, have fuelled the pick-up in defensive strategies, which may intensify if wheat prices continue to edge higher.

Drifting along for the ride

While wheat traders and market commentators have pointed out wheat crop concerns in the Southern hemisphere as the main reason for wheat’s recent recovery, it is likely that wheat also borrowed strength from the rising corn and soybean markets in recent weeks. Chicago soft wheat prices have rallied roughly 11 per cent, or more than 40 cents a bushel, since October 1. This more or less matching the advances seen in both the corn and soybean markets over that period.

Corn and soybeans have gained as the U.S. harvest of both crops nears completion and end-user demand for those commodities picked up. Chicago wheat’s rally, however, came despite brisk advances in U.S. winter wheat sowings as well as a well-known global surplus of feed-grade wheat stemming from large global harvest earlier in 2014.

As such, many traders viewed the price strength with skepticism, with some establishing fresh short positions in the market on the expectation that those positions can be bought back at lower prices in due course.

Other traders, however, were reluctant to swim against bullish tide in the futures market, and instead opted to put on their bearish bets in the options arena, where the price of put options declined steadily as the underlying futures markets advanced.

Open put positions at the $5.00 March strike increased by over 56 per cent or 1,355 contracts between October 15 and November 3, while open interest at the $4.90 strike climbed by 36 per cent and 1,470 lots. Additional gains were also evident at the $4.80 strike.

Diminishing demand

The steady erosion in the projected demand for U.S. wheat has also fuelled bearish posturing in the Chicago market lately.

Since beginning its monthly balance sheet projections of U.S. wheat for the 2014-15 crop year in July, the U.S. Department of Agriculture has dropped its demand assessment by 30 million bushels on the back of heightened competition for domestic feed demand by corn and an aggressive export arena characterized by abundant supplies in both Europe and the Black Sea region.

This reduced usage tally was already more than 300 million bushels smaller than the demand total for the 2013/14 crop year, and so the extra consumption cuts seen in recent months have been viewed as additional bearish fodder for traders.

What’s more, the recent rally in low-grade U.S. wheat values is unlikely to reverse the weak demand environment, especially after the price of U.S. feed wheat for export rallied to its largest premium to Black Sea supplies since May in recent days, effectively ruling the U.S. out of any serious wheat export consideration over the near-to-medium term.

Combined with an historic tendency for Chicago March wheat to lose ground to March corn over the November-to-February period (as corn demand picks up when winter wheat enters its dormancy period), the recent diminished competitiveness of U.S. wheat has heightened trader expectations for a period of declining U.S. wheat prices later in 2014 and early 2015.

This should bode well for those players who used the recent unexpected rally to establish bearish downside protection through put options.

Gavin Maguire is a Reuters market analyst. The opinions expressed are his own

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