Short-Dated Options Take Off

KATIE MICIK, DTN MARKET EDITOR FRI, 2 AUG 2013

SDNCOs Are Part of the System to Set Floors and Ceilings on New Crop Options
More than 1 million short-dated new-crop options have traded since the products launched in 2012, making it one of CME Groups most popular agricultural product launches. Im not sure if its the quickest option contract to a million contracts that weve ever launched, but I imagine it probably is, said David Lehman, managing director of commodity research and development at CME. Short-dated new-crop options (SDNCO) help farmers and elevators tailor price protection to the times they need it most while cutting down on premiums. A new-crop futures contract December corn, November soybeans, July wheat underlies the option, which has expirations that roughly correspond with planting, emergence and pollination. CME announced on Tuesday that its going to list a SDNCO on its recently acquired Kansas City hard red winter wheat contract that will be available to trade on Aug. 26. It will also list 2014 corn, soybeans and soft red winter wheat SDNCO the same day, a change from last years early January listing, which Lehman said was a result of feedback from brokers. CME will also add a March expiration to the corn and soybean options for 2014 in addition to the current May, July and September expirations. The wheat options expire in December 2013, March 2014 and May 2014. It took a while for CMEs standard options to gain traction when they were first released in the early 80s, Lehman said, so to see this swell of volume in such a short period of time, it reflects the growing sophistication of producers. These short-dated options have short maturities and less time value, therefore providing a more economical tool. I think its a natural product for producers to embrace. There wasnt as much of a need for options in the 1980s: Price ranges were smaller, DTN Senior Analyst Darin Newsom said. Since the rules of the game changed in 2005 and volatility skyrocketed, options have become a more important marketing tool for producers, end users, merchandisers, etc. to try to alleviate some of the risk associated with volatile changes in market direction, Newsom said. In 2005, noncommercial traders, or speculators, were allowed to hold much larger positions in the futures market. Increased participation of noncommercial traders, including high-frequency traders who use computer algorithms, makes it more risky for those dealing in the actual cash commodity, Newsom said. Crop insurance which sets a floor price similar to a put offsets much of the increased risk, but not all. The ability to set floors/ceilings for a variety of timeframes now (long-term options, short-term options, etc.) is increasingly important to commercial traders, particularly around report days. Traders can now offset some of the risk of unknown headlines that feed the algorithms and create chaos, Newsom said. Short-dated new-crop corn options set a daily volume record on June 27, one day before USDA released its acreage report, which showed an increase in corn acres when traders expected a decline. The corn market tanked. Open interest ahead of the July expiration (the last trading day of June and the USDA report day) reached a peak of more than 240,000 contracts, according to CME Group. The protection SDNCOs provide against USDA reports is key, Newsom said. This is something was not available at an affordable price before, with traders having to buy Dec corn or Nov bean options, paying option premium through the fall. In my opinion, one of the best ideas CME has had to mitigate some of the increased volume and volatility it has thrived on since 2006, he said.

Now CME hopes the momentum transfers into its wheat SDNCO. The SRW SDNCO was available to trade last year, however, no one bought or sold them. On the HRW contract, there is definitely interest in using these, Lehman said about feedback hes received. Were looking forward to that, and seeing if once we see some volume in HRW short-dated product if that bleeds over into the SRW contract as well. Volume in wheat futures and options is much smaller than in corn and soybeans, and Lehman doesnt expect the wheat SDNCO to generate the same volume. Wheat growers tend to prefer the cash markets to hedging on the board, but Newsom said theyre just as vulnerable to large swings in the market. I think we will see volume/open interest increase quickly given the changed dynamics of the marketplace and the track record of the same options in the other markets, he said.