Market Matters Blog
Todd Hultman DTN Grains Analyst

Monday 06/23/14

Meal Did What???

Friday afternoon, I was preparing my presentation for the closing market video. I would finish, I thought, with a collection of yield anecdotes from this week's 2014 Kansas Wheat Harvest Reports and decided to highlight the soybean meal market in the first chart slide. In the 1:00 p.m. Quick Take, I wrote: "July soybean meal is on track to post its lowest close in nearly 13 weeks, raising larger concerns that China's demand for old-crop feed needs has pulled back." Friday had been a very quiet day and prices in the soybean complex had barely moved since 10 o'clock. It looked like traders had already scrammed for the weekend.

The chart above shows the final minutes of trading in July Soybean Meal on Friday, June 20. Meal had been trading lower all day long with very little volume and was headed toward a sleepy Friday finish. At 1:07 p.m. however, prices began inching higher on gradually increasing volume and then erupted into a frenzy of buying in the final minutes of trading before settling up $8.00 a ton at $459.20.

After some last-minute scouring for news, I looked up to see July meal quoted up $14.50 on the day. What??? No, that can't be right! It was just down $6 a couple of minutes ago. I brought up my one-minute chart in ProphetX and saw all I needed to see -- a late surge of high-volume buying in the final minutes of trading had caught the market off guard on a sleepy Friday afternoon. One-third of the day's total trading volume took place in the final five minutes. This was an option-expiration day ambush.

For those not familiar with the unique risks of option expiration day, let me try to explain. Put and call options are valuable market tools, used by both hedgers and speculators and they derive their value from the futures contracts that they are based on. Options also have time value based on their remaining contract life. However, on the day of expiration, time value dwindles to zero and the option's value becomes completely dependent on the price of the futures contract. A small change either way in the price of the futures contract can make a big difference in the value of the option at expiration.

A good example of this Friday was the July $450 meal call. The owner of this call option has the right to buy one futures contract of July soybean meal at a cost of $450 a ton. Since the July futures contract was trading at $445 earlier on Friday, this call option looked like it was going to expire worthless and could have been purchased for 35 cents a ton or a total cost of $35 or less on Friday around mid-morning. In fact, someone did buy 60 call options shortly before 1:05 p.m. for a total cost of $10 each. Why would someone just throw away $600 on a bunch of call options that were about to expire worthless?

Hmmm....

What if they knew someone with a lot of clout in the market that would be willing to go in at the end of a sleepy, low-volume Friday and hit the market with a big rush of buy orders? The result was that the $600 throw-a-way finished minutes later as 60 call options worth a total of $55,500 -- not a bad day of work, if you can get it. Of course, many more of those options could have been purchased earlier with a little planning.

If you feel your blood pressure rising at the unfairness of this manipulation and see this as another abuse by the One Percent sticking it to the little guy, you are not alone. But the reality is that the unique risk of option expiration day in grains and other markets is not likely to change anytime soon. The important thing for those who use the futures and option markets is to be aware of the risk that this special day carries so that they can protect themselves accordingly. It is common for producers to be short call options as a way of enhancing the price that they receive for their grain. As a DTN Grain Market Analyst, I no longer trade in the futures and option markets so that you can trust my neutral bias. When I did trade, however, I would always take profits on any short option positions that were close to their strike price before expiration day to stay clear of the kind of ending that we saw Friday. I would much rather buy back a call for 30 bucks than let it sit there and hope that nothing bad happens.

Friday's higher close in meal was crazy and this week will show if meal's higher prices can be sustained. I suspect prices will correct back from Friday's aberration. The four-month uptrend in July meal ended on June 12 and prices have fallen since then with concerns that China's demand is pulling back. It is understandable to get upset when we see obvious cases of market manipulation, but the larger lesson should not be lost. Markets are not for the faint of heart and the risks are often well-disguised. At times, low-volatile market behavior can lull us into a false sense of security, but do not succumb to the temptation of complacency - these are shark-infested waters.

Todd Hultman can be reached at todd.hultman@dtn.com

Follow Todd Hultman on Twitter @ToddHultman1

(CZ/AG)

Posted at 7:45AM CDT 06/23/14 by Todd Hultman
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