Three Top-Heavy Markets Looking Ripe for Collapse

October 16, 2007

The crude oil market has still been on a tear, and from what we see it is largely fueled by the hedge funds. Chances of a hurricane hitting the Gulf area remains slim, and we are past the peak driving season and pre-cold weather, so without a catalyst for prices to keep soaring we are going to continue to predict a beat-down for this market.

We found this quote from our favorite energy web site, Zman's Energy Brain: "While I forecast that supplies will grow somewhat tighter in the next two months there seems to be little justification for oil at these levels. Even if there is a substantial draw down this winter the U.S. will very likely remain amply supplied with crude. Heating oil may be a different story and I believe the EIA's 28% YoY price tag growth for the 4Q is likely to be exceeded."

We are looking at the Dec. Crude Oil 78 puts, priced now at .51 ($510). Dec. crude ended the day at $86.56 per barrel, and if the short-sellers jump on board we can easily see a $6.00 to $8.00 drop in prices quite quickly.

Again, our plan is to wait out the Wednesday morning AIP/EIA Energy Stocks report at 10:30 am. If crude breaks down this time we're going to jump on this.

Soybeans Look Ready for Dip
The soybean market, like most of the grains, has been jumping all over the place. Recent reports of a possible drought in Brazil caused bean prices to jump over $10 per bushel, but that didn't last for long. Now, the news is that the Brazil drought won't be so bad. Also, reports of some smaller harvest yields have failed to move the market.

Like they say, a bull market needs steady news to keep it fed. We think beans will take a short-term drop to the $9.00 area, and we are looking at the Jan. '08 9.00 put. It's priced at 7.5 cents, or $375 per contract. This would give you a return of 3-to-4 times your investment if soybeans dropped to $9.00.

Top in Place for Canadian Dollar?
The Canadian Dollar also looks like it may have topped out, and we see some movement in the U.S. dollar index to the upside. The Canadian dollar is on the longest sustained run in decades and has yet to retrace any significant amount of its over 50% rally. We think it is ready for a fall back to the $1.00 range (it is currently trading at $1.0207). A Dec. 1.000 Canadian Dollar put is just $300, and it would also triple in value if the Canadian Dollar fell back to the $1.00 level.

Update on Orange Juice
We had an excellent payday from our OJ calls. We got out of one of the Nov. 140 calls on Oct. 10 at 7.00 for a gain over cost of $757.00. We punched out of our second Nov. 140 call on Friday the 12th after the OJ crop report came out lower than anticipated. The market was all over the place and we bailed at the close for just 5.00, a profit of $457 over cost.

Finally, we took profit on Monday the 15th on our Jan. 160 call when the market jumped back up, getting 5.50 for it, or $555 over cost. Not too bad for a month's worth of work!

We decided to get out of the OJ trade for several reasons. First, the Nov. calls were expiring at the end of this week. If they moved down and "out-of-the-money," or less than 140, then they would lose most if not all their value very quickly. Second, we got into the trade because we predicted Florida would get smacked by at least one hurricane in September or October. That never happened, so our reason for being in the trade disappeared.

We got lucky that the crop report came out last Friday with lower than anticipated figures, and that popped the market up to where we expected to take our profits. As they say: plan your trade and trade your plan.

We did leave some money on the table (a lot in the case of the Nov 140 calls: they traded up to 18.00 today, or $2,700.) That was painful to watch, but we were playing with fire keeping the Nov. calls so close to expiration.

If you have any questions or comments please send me a note at davidbrown@midwestfutures.com.

Futures and options trading is speculative and involves a high degree of risk. The risk of loss can be substantial. Neither the information presented or any of the opinions expressed constitute a solicitation for the purchase or sale of any commodities.