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Commodity Options: What 2011 Taught Us

This complimentary article from Options Profits was originally published on Dec. 23 at 10:43am EDT. Subscribers get more than 40 options trade ideas every week and exclusive commentary from over 10 experts. Click here for more information.

Merry New Year as they say in the infamous holiday futures trading flick Trading Places. Though the film took liberties with the actual transaction process in the pits it did a great service in introducing the world to commodities.

It had an impact on me as a youth for sure and shifted my focus from stocks to the greater opportunities in the markets that are vital to everyday life, commodities. Gold doesn't grow on trees you know but it can be just as vital to your wealth protection.

The lesson to take from 2011 is not what happened but more what did not.

No market crash, correction yes, but to be expected after a multi year recovery run. No double dip recession, either. The economic numbers are actually on a positive trend with 21 consecutive months of private sector employment growth.

The volatile price moves played both sides (up and down) as the heightened emotions led to extreme reactions to most news or information.

Price Positive

The Net/Net has the stock market measured by the S&P 500 down less than one percent on the year with a few sessions left to push positive. A rally of nearly 15% since the October low has erased the losses.

WOW, that price action is a positive reaction to what everyone would agree has been a year long onslaught of negative news and opinion. The measure of something/someone when things are bad is a much better indicator of true value than when things are good.

The health of the Equity market often determines the overall asset market direction including commodities. And importantly, when that doesn't happen there will be commodities that follow their own supply and demand dynamics of finite resources - it's a win/win. Stock Spring

Typically the longer a market trades within a trading channel, S&P 1250-1350 January through August, the larger the resulting breakout move.

As things currently stand another attempt to push prices back into the previous range can be a setup for the next major run. The overall multi year trend, market resiliency and improving economic fundamentals add to the underlying support and bullish breakout bias.

Commodity Sale

Last weeks briefing talked about the importance of commodities as viewed by the CRB index basket holding strong above the October lows even though the US Dollar made new yearly highs. The turn in our favor for both sets up a great base for a bounce and buys.

Gold holds the $1600 channel support on a weekly basis and crude sits solidly above the Oct $95 pivot point.

As a group commodites are under appreciated and undervalued now with prices at 20% below the summer highs. In comparison, stocks are less than half of that from the year peak. The rubber band relationship should make that discount attractive to investors as they gain confidence in the continued rebound.

The Crude Oil as a barometer theory tells the story of strength as prices are near triple digits today once again. A move above $105 sends black gold to $125 plus as a good sign for continued economic expansion.

An initiative to slow demand for Crude, interesting the oil itself not the roundabout gas conservation we have always heard, illustrates future scarcity fears of finite resources. This from the LA Times:

"California launches a campaign against the widespread notion that oil changes are needed every 3,000 miles. Officials say the practice wastes millions of gallons of oil a year. Many automobile owners are spending more than they need on motor oil, believing that it should be changed every 3,000 miles even though almost no manufacturer requires such an aggressive oil-change schedule.

The long-held notion that the oil should be changed every 3,000 miles is so prevalent that California officials have launched a campaign to stop drivers from wasting millions of gallons of oil annually because they have their vehicles serviced too often.

"Our survey data found that nearly half of California drivers are still changing their oil at 3,000 miles or even sooner," said Mark Oldfield, a spokesman for the California Department of Resources, Recycling and Recovery, which has launched the Check Your Number campaign to encourage drivers to go with the manufacturer's recommendations.

Improvement in oils, friction proofing and car engines have lengthened the oil-change interval, typically 7,500 miles to 10,000 miles for most vehicles.

Changing motor oil according to manufacturer specifications would reduce motor-oil demand in California by about 10 million gallons a year, the agency said.

The state has created a website, checkyournumber.org, where drivers can look up the suggested motor-oil change interval number for their vehicles." Metal Musings Politics aside, if possible, a conversion from paper Dollars to coins makes sense financially. The cost of printing money costs much more money to print. If you believe in the tangible value of commodities this is a good first step in doing away with some printed paper.

Governments around the world have converted much of the paper print into coinage that lasts longer, maybe forever, in circulation. A Dollar on the other hand has limited life from the physical bruising that we put them through everyday.

The trickle down economics bring it All Back To Commodities with less demand for Cotton and a clamor for industrial metals.

Take a read of this opinion piece from Politico:

"Each year, the United States produces roughly 4 billion $1 bills; most of these are needed just to replace the 3 billion $1 bills that are pulled from circulation, shredded and sent to landfills annually. At the same time, a $1 coin lasts for 30 years or longer -- check your pockets if you don't believe me -- and during its lifetime, it could do the job of up to 17 $1 dollar notes. The government's own watchdog, the nonpartisan Government Accountability Office, has long advocated the elimination of the dollar bill. Its most recent report in March estimated that switching from a $1 bill to a $1 coin would save at least $5.5 billion over 30 years. Previous studies, dating back to 1990, have put the savings at more than half a billion per year. If we had listened to the GAO the first time, we could already have saved more than $10 billion."

My Canadian friends have embraced the Loonie and Twoonie ($2) coins as a way of life in the great white north that enjoys a renaissance of oil profits to fill their pockets.

Our March CD$ option play had doubled and forced us to sell half of the positions to pocket gains. "Forced" is a very strong description but the strategy to lower the overall risk to zero has no downside.

The bounce back to the 98 level puts the all gain play's worth above $1000 with over three full months for future gains. A Dollar drop below 78 lights the wick on this profit pipeline. Watch for Aussie gains as well when the Dollar demise resumes.

Future Forecast

Much like the harvest brings the season to a close new life is just around the corner. We have many seeds planted to produce with 2012 July Corn and Oct Sugar options some of the agricultural bounty ahead.

Bottoming patterns have been made in Coffee, Corn, Sugar, Cotton, Beans and Wheat after sharp declines. The weather outside may get frightening as the song says so watch for upside price shock potential.

Chicago is on pace to have the highest precipitation on record for the year. That sews another variable in the soil as this grain breadbasket area heads into spring volatility. Any disruptions in the growing process hurt the ability to grow the seed and add value to price performance. Now let's take a look at our current positions...

Current Positions (Prices as of market close on Wednesday, December 21)

March 2012 Aussie Dollar (ADH12) 105/110 call spreads at 160 points ($1,600): The recent highs above 102 failed two weeks but have reclaimed the 100 level again for another attack. The last Dollar move back to near 78 December 9th had pushed the $AD back to our 10250 entry area. The resistance above at 104 highs sets up attack on 106.50 then 110 highs. The position closed at 81 points ($810), which represents a 49% loss. HOLD.

July 2012 Corn (CN12) 700/850 call spreads at 32 points ($1,600): A nearly 50 cent rally in a few sessions has Corn ready to rumble. The asset crush had taken corn back down to $6.00 weekly pivot before reversal. July corn prices had rallied to monthly highs at $6.85 resistance before the downfall. A move back inside the range from $6.80 to $6.50 lows Oct 11 is a very good sign to test recent highs again. The breakout above that highs at $8 projects a run to double-digit $10 Corn. The position closed at 26 points ($1300), which represents an 18% loss. HOLD.

October 2012 Sugar (SBV12) 25/31 call spreads at 135 points ($1,512): A bottom will be confirmed with a run above 24 cents after a month long base. Sugar prices sit at the critical now quadruple bottom at 22.5 cents here at September and October three-month lows. This support base also coincides with the June breakout that rallied to contract highs at 26 cents. The previous upside resistance levels at 24 and then 24.5 are now areas to watch for breakouts. The position closed at 101 points ($1,131.20), which represents a 25% loss. HOLD.

March 2011 Canadian Dollar (CDH12) 100 call at 160 points ($1,600): Half of this play was sold at 100% profit to reduce the trade risk to the ZERO exposure level. CD$ prices had rallied to the 101 area to fill our standing exit order months ago. The upside resistance sits at the highs above 99. Support sits at the 96 area for now. A renewed push down in U.S. Dollar Index to 78 again sends the CD$ to par. The first upside target at 102 puts this play deep IN THE MONEY. The highs at 106 and low at 94 near term upside objective at 100, which is our strike price. The position closed at 106 points ($1,060), which represents all profit after the 1st half sale. HOLD.

February 2012 Gold (GCG12) 1850/1950 call spreads at 16 points ($1,600): The breakdown to the $1600 channel bottom warrants attention. Crude and Stocks have held as Dollar strengthened but it has hit metals especially hard. New relative highs at $1800 weeks ago still target a goal above $2000 an ounce on a breakout of the trading range. Gold pushed through crucial $1,680 last month resistance with force and needs to recapture it again to resume rally. The move above previous congestion at $1,680 sent prices higher to the $1,750-plus and a resumption of the upward trend. The position closed at 2 points ($200), which represents an 87% loss. HOLD.

March 2012 Silver (SIH12) 47/48.5 call spreads at 32 points ($1,600): New lows below $30 have buried the metals. Only a bullish move above $35 again revives trend. An almost three-month trading range between $44-38 led to a price breakdown to $30 in a few quick days. The extreme low hit $26 before bouncing back to above $33 again after a stall a couple weeks ago. The position closed at 3 points ($150), which represents a 90% loss. HOLD.

January 2012 Soybean (SF12) 1400/1500 call spreads at 28 points ($1,400): Highs at $12.80 capped prices weeks ago as beans have been in solid downtrend and moved below $12.00. Only a climb back into the $13-14 channel could be a positive. The position closed at .50 points ($25), which represents a full loss. HOLD.

It ALL Comes Back to Commodities!

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