Most investors who would like to get exposure to soybeans would look no further than the soybean ETF $SOYB. While this is typically an excellent choice, we have to do some serious digging in and around this soybean ETF to make sure it is the one for us.
ETF’s are very popular these days as more and more institutions are competing for retail investor dollars by creating these products. The sell for these ETF’s and institutions is simply; create a product where retail investors can get exposure to many of the products they normally wouldn’t be able to. This can be a wide variety of products, going all that way from a basket of stocks to a replacement for an extra large futures contract.
The soybean ETF $SOYB is another example of the latter where not all individual investors have the permission to trade futures contracts but can now get direct exposure to the price of soybeans. Before we invest our hard earned money in $SOYB, we must first make sure it is the right kind of product for us.
The soybeans futures are an example of a global grain product. This product is primarily produced in the United States with Brazil and Argentina in a close second and third. Soybeans are used in many foods as well as industrial applications such as biofuels and biodiesels.
These futures contracts for soybeans trade on the CME during Globel hours.
We do not recommend trading soybeans futures as the contract size is too large for our appetite.
One soybean futures contract is the equivalent to 5,000 bushels of soybeans. The minimum tick value, which is the smallest distance between any two prices, is 0.0025 and is worth $12.50. With the price of one soybean futures contract currently trading for $975.50, the total notional value of one contract is equal to $48,775.00. To make matters a little worse, those contracts use 21:1 leverage and only require $2,310 of initial margin to trade, and with the current one day expected move for soybeans futures, one can expect to make or lose around $100 per contract.
This is too large of a contract as we believe there is soo much leverage for holding just one contract. There have to be smaller and more efficient ways of getting exposure to the price movement of soybeans.
Soybean ETF…The Teucrium Soybean Fund
In order for us to be confident in trading the soybean ETF $SOYB, we must find out two things:
- If $SOYB is highly correlated to the price of soybeans
- If $SOYB is liquid enough
If both of these points check out, we can ride off into the sun because we would have found ourselves an excellent and efficient way of getting exposure to the price of soybeans without our position size getting out of hand.
To find the correlation of the soybean ETF $SOYB to the soybean futures contracts, we must take the price movements of both products every day over the last year and compare them to one another. This will tell us how similar the price movements between the two are. Anything over a 75 is what we would like here.
We can clearly see that these two move almost exactly with each other. Fantastic. What this means is that if we go ahead and purchase $SOYB, we will get 98% of the price movement of the price of soybeans and soybean futures. This is exactly what we were hoping for.
We already know that $SOYB and soybean futures are very correlated. All we need to do is find out if $SOYB is liquid enough for our money and we are good to go!
Liquidity is the single most important filter we have before deciding to enter a trade or investment. If we find liquidity, we react on the opportunity that presents itself without any hesitation. If we do not find liquidity, we walk away. Plain and simply.
We need to make sure the following two things are true:
- The ETF has strong stock liquidity
- The ETF has strong options liquidity
If one of the two is missing, we cross it off the list and walk away.
Let’s jump right in. What kind of stock liquidity does the soybean ETF $SOYB have? We need to see volume in the millions here.
This volume is horrific. We can pretty much end this discussion now. With only 15,202 shares traded on Friday, we barely get a total notional value of $282,149.12. That is non-existant.
While we would love just to cut this off and go home for the day, examining the options liquidity for the soybean ETF is important to see all of the steps we go through BEFORE even considering a single investment or trade. Here are the four things we need to see for options liquidity:
- Volume in the thousands
- Monthly and weekly expirations
- Bid/ask spreads pennies wide
- Open interest in the thousands
Let’s dive right in even though we pretty much already know what this is going to look like.
What about expiration cycles?
Everyone gets the monthly expiration cycles out of the box.
This is equally as terrible. There are no options contracts here that even have bids out of the money.
Last, but probably least, we have the open interest count. Typically, we like to see this count in the thousands because it tells us big time investors and money managers are placing sizeable bets in these products. How bad do you think the soybean ETF $SOYB’s are?
Realistically, this product should be de-listed. In my over a decade of trading, I don’t think I have ever seen an ETF have such little liquidity, participation, or competition.
The soybean ETF is a perfect example of what NOT to trade or invest in. If we ever want to get filled or enter a position we are going to have to take a sizeable loss to do so. We NEVER do this and will never trade the soybean ETF $SOYB. In fact, after finishing this article, I will never speak about it again.
What Do We Do Now?
We have just proven that although $SOYB gives us the price movement we would like, its liquidity is so bad it’s not even worth discussing. There is zero liquidity in the stock or the options market.
But, we still want exposure to the price of soybeans, so we need to find another product that not only gives us the same kind of price movement but also provides us with a liquid stock and options so that we can give ourselves the best chance to make money. Sounds fair, right?
How Can $USO be the Soybean ETF?
But we found something, although not great, we found something that would give us similar exposure to the price of soybeans while as the same time provide us a liquid product to trade and invest in.
Readers of this blog will know that we don’t love $USO. However, it gives us the best crack at trading and investing in soybeans.
$USO’s correlation to $SOYB is not 70, but it is 67, which means 67% of the time the price movements for those two products are the same.
I will take a 67 correlation any day of the week considering $USO is an incredibly liquid product. It trades million of shares a day,
tens of thousands of options contracts,
with monthly and weekly expirations,
and tens of thousands of open interest count across the board.
$USO is a perfect example of a product with the type of liquidity we are looking for!
What Have We Learned Here?
We have learned quite a bit including the following:
- The best way to get immediate exposure to the price of soybeans is by trading the soybean futures
- Those soybean futures are too large of a product so we must find another way
- There is a soybean ETF $SOYB that gives us the same price movement as soybean futures
- $SOYB is the least liquid ETF in the world and is not liquid enough for us to trade
- Because the $SOYB is such a bum, we must find a replacement
- $USO has a 67 correlation to the price of soybeans and is incredibly liquid
Because of these reasons, if we want to have exposure to the price of soybeans, we trade the most liquid product that gives us strong correlation to soybeans. In this case, it is NOT $SOYB; it is the United States Oil ETF, $USO.