Regulatory Reaction
Fundamentals
Wheat futures are lower this morning, due to better than expected growing conditions and the CFTC crackdown on speculators. Recent rains may increase the Australian crop size by 3 percent over prior estimates. Meanwhile, the cool summer and ample rains have improved crop conditions in the US and Canada. Rains have been steady and have not interfered with the winter Wheat harvest, which is 72 percent complete. Traders are closely watching the CFTC's actions regarding exceptions to position limits for certain index traders. Index traders have been blamed for the disconnect between futures and cash prices,, as well as increasing the overall volatility in the Wheat market. The lack of convergence in the futures/cash basis has made it difficult for farmers and end users to hedge their cash positions effectively. The lack of convergence has also been blamed for rising prices for foods such as cereals, breads and baked goods. The CFTC is in the awkward position of trying to limit the influence that index traders have on commodity prices, while also trying to make the market accessible for a broad spectrum of traders. The Commission is looking at doing away with the exemptions, which would be seen as a bearish force for the market. There is also the question of how much time will be alloted to comply with position limits. If funds are forced to comply with position limits rather quickly, prices could drop very sharply, and very quickly, because of the number on contracts being sold. Also, opportunistic traders may jump on the short side of the market to take advatage of a fund liquidation, which could add further downward pressure. Needless to say, whatever decision the CFTC comes up with will have a major impact on the market. It has already garnered more attention than any crop related news in recent weeks.
Trading Ideas
The immanent CFTC action or inaction could cause volatility to kick-up in the Wheat market, so traders may opt to take the cautious approach and stay on the sidelines. A long straddle or strangle would normally be considered by many traders to be the logical approach in such situations, but the high volatility and time premium on December options require substantial investment and an extremely large move to break even. Some traders with a short bias could opt to take a short position with a protective call and short put. An example of such a potential trade would be to sell a Dec future at the market and, at the same time, buy a Dec 580 call (WZ9580C) and sell a Dec 530 put (WZ9530P), for a debit of 5 cents, or $250. In this strategy, the call protects from losses beyond 580 , but gains are also capped off at 530 by the short put.
Technicals
Turning to the chart, the Dec Wheat contract has bounced back after testing lows made last December. Prices, however, have not been able to cross above near-term resistance near the 575 level. Failure to break resistance here could result in a retest of recent lows. If prices manage to fall below recent lows of 538, the market risks breaking out of the wide sideways range that it has been trading in this year and creating a new downtrend. Prices have been unable to hold the 20-day moving average after crossing over on Friday and Monday.
Rob Kurzatkowski, Senior Commodity Analyst
