Crop prices have been moving sharply higher over the past several weeks due to a number of different factors.
While the Midwest is dealing with cold and snow, farmers in California are facing one of the most severe droughts seen in decades. Low levels of rainfall have left reservoirs well below normal levels and have made it increasingly difficult for farmers to irrigate crops.
Expectations for the next few months continue to be bleak for California and other areas of the southwestern United States. This could pressure crop output and result in shortages and agriculture price spikes.
Internationally, political tensions are also causing fear of supply disruption. For instance, Ukraine was expected to be the third-largest corn shipper this year, but that's in doubt with Russian troops on the country's border. Military action could have a destabilizing effect on the entire region, and disrupt supplies of grains that were previously expected to be shipped to global consumers.
With all of these issues causing supply concerns for wheat and corn, among other agricultural products, prices for grains have been rising for several weeks. Take a look at the chart of the PowerShares DB Agriculture Fund (NYSE: DBA), which tracks a commodity index composed of futures contracts on soybean, cocoa, coffee, wheat, cattle, sugar and corn, among other commodities:
The price increase also led to higher premiums for option contracts. Today, I want to set up an income trade by selling puts on DBA, creating an 18% per-year income stream.
To capitalize on this opportunity, we are going to sell the DBA May 28 Puts, which are trading near $0.70. By selling these puts, we agree to buy 100 shares of DBA per contract at the $28 strike price.
This purchase price is very close to the current price of DBA, but since we will be receiving $0.70 per share in premium from selling the put options, our net cost will be $27.30. This is a significant discount to the current price, especially considering that the average daily trading range for DBA is only $0.30.
If DBA remains above $28, we will be able to keep the $0.70 per share ($70 per contract), which represents a 2.6% profit over the $27.30 per share ($2,730 per contract) of our own capital we will need to set aside in case we are required to purchase shares of DBA. Since this income will be realized over the course of the next 52 days, our per-year rate of return actually comes out to 18%.
Of course, if DBA trades back below $28, we will be assigned the shares. Given the long-term growing demand for food, and the lingering ecological and political challenges for farmers, I am willing to take ownership of this ETF and possibly hold for long-term gains.
Another option for income traders would be to turn around and sell covered calls against the position once the puts are exercised. This would tack on more income to the trade and would further reduce our risk by lowering our cost basis.
Action to Take --> Selling puts is a great way to generate income in your investment account and potentially pick up shares of a stock or ETF at a discount. I use the strategy on investments that I would already like to own. That way, if I am compelled to buy shares, I am happy to be building exposure to the area. And if not, then I am pleased to be generating income from the premium I receive when selling the puts.
This article was originally published at ProfitableTrading.com:
High-Income Agriculture Play Could Generate 18% a Year