Update on Recommendations

Here’s an update on the trades we’ve been looking at since the letter I sent you two weeks ago. Below is a copy of the letter with updated charts to show how the trades progressed. My new comments are in italics. Hope you find this interesting.

Here are also a few of the markets on our “radar screen” that we are monitoring for either current trades or ones we are waiting to jump into:

April Live Cattle:
April Cattle has been stuck in the lower band of a $98 to $91 trading range. We’re looking at selling $91 put options on this contract for a $300 to $400 credit. They expire on April 4. In addition, we would look to either buy the April futures or sell a $98 call option if cattle begins to move upward. Each $1.00 move in cattle is equal to $400 if you hold a futures contract.

We sold an April 91 put for a $380 credit. While we had some nice moves up for a few days in the past two weeks, the pricing of the 98 calls were not attractive enough to take. The cattle market looks to be consolidating, and most analysts are looking at the further-out months to look to get long as current inventory is brought to market. We are also looking at the further out lean hogs (June contract) to get long very soon. For now the April 91 puts have dropped to $240, giving us a nice profit.

May Orange Juice:
Orange Juice is one of the few futures contracts that are not experiencing insanely high prices. A strong supply of juice from Florida and Brazil, along with high prices at the store level, has kept the OJ contracts at depressed prices. We think commodity funds will be looking for more areas to put their money in, and OJ may be the next market to catch their eyes.

In addition, hurricane season is coming in just a few months. Florida did not have a single strong hurricane last year, but what’s the chance of that happening again? Hurricane scares often move the OJ futures contracts sharply higher. We are looking at a few ways to play this market:

First, we are looking at a bull call option spread in May OJ – buying the May 130 calls for around 4.75 cents ($712.50) and selling the May 140 calls for around 1.90 cents ($285) for a net cost of around $427 for each spread. There is good resistance in the 140 price range, and the options expire on April 18, so we have time for the trade to work out. Ideally, we’ll see a move back to near 140, then start moving back down. Cash out of the in-the-money 130s for about a $1,000 profit and let the 140s drop to around $200 or less and cash them out or let them expire worthless.

We entered the bull spread on the 20th, buying the May 130 call at 4.90 ($735) and selling the May 140 call at 2.15 ($322) for a net cost of 2.75 points, or $412. We almost bailed on the trade on the 22nd when the market took a huge slide down but waited it out. We’re nervous about today’s price action as the contract failed to close near the higher points in its range and that seemed to hit resistance at the trendline. We are now thinking the sell side of this market is the place to be near term (we still like calls in the further out contracts) and will look to bail on this position on weakness on Monday and switch to May 125 puts in the 3.75 point area ($562) or the May 120 puts for about 2.15 points ($322). For the current trade the spread has widened slightly and we’re up about $44.

In addition, if the OJ continues to fall, we could look at picking up some May 135 calls or 140 calls on the cheap, and maybe sell some further out calls or puts help finance the trade.
Next, taking a longer term outlook for OJ, we look at a similar trade with the July or September contracts and look for a hurricane play. A July 145 call is only about $450 now, with expiration at the end of June. September is much more costly with a 145 call at over $800, but it won’t expire until Aug. 15. Margin on an outright OJ contract is just under $2,000, so buying some longer-out contracts may also be a good way to go as we would not have to worry about time running out on the options.

May Wheat:
The wheat market, as well as corn and soybeans, have been crazy this past year. These markets have been so volatile it’s been hard to find logical entry points. We feel, however, that wheat is especially due for a correction in price. We don’t like stepping in front of moving trains, but we also can’t overlook that more money can be had on price drops as on increases.

We’re looking at a bear put spread for May Wheat – buying a $9.00 put for 27-cents ($1,350) and selling an $8.50 put for 17.5 cents ($875) for a net cost per spread of just $475. These options expire on April 24, so we have two months for it to work out. Profit potential is on the $1,500 range, so risk versus reward is good.

We didn’t enter the put spread last week as the market drifted sideways and failed to take out the more recent lows. Then the daily limit curbs came off and the wheat market went crazy! Once limits were expanded and margins increased prices started to fall, and we see $9.00 as being the next logical stop as wheat drives lower. We may have some bounces along the way, but we think $9.00 is a reachable target in the next two months. We entered this trade today, buying the $9.00 May puts for $17 cents ($850) and selling the $8.50 puts for 11 cents ($550) for a net cost of $300. We purchased just two sets for a cost of $600 as the margins on wheat will increase the further prices drop. At the end of the day we were up three cents on the spread for a profit of $150 each, a nice 50% increase for just a few hours!

Remember, as this is a debit spread we cannot lose more than the net cost of the options.

Coffee:
The coffee market is another that has experienced huge price movements recently. We’re looking for a pull-back into the 140 to 145 range to get long again, either with outright futures or options. Coffee should be a strong market his year as it is an “off” production year for Brazil, so supply could be a huge issue.

Coffee generally stays within a range of 120 to 150 most of the time, and we’ve been successful playing off those extremes with call option spreads and selling puts. If we can get the correction, we’ll be pulling the trigger to get long and ride another move to the 155 to 160 area.

Wow. Talk about a rocket of a market. We’re kicking ourselves for not just getting in long anywhere, but that’s not how we trade. Today’s trading action could be looked at as an “exhaustion” move as the contract jumped to new record high only to settle at the extreme low of the day. What I want to see are a few down days. Then I’ll draw a trendline down from the high. When we start moving up through that we’ll get long. Until then my long-standing phobia (and uncanny track-record) of buying the extreme highs will keep me on the sidelines for this market. Another possibility I’ll be sketching out on Monday would be selling out-of-the-money puts sometime in mid-March when the contracts have less than a month until expiration.

Other markets we’re focusing on this year will be the U.S. Dollar (long the index or short the foreign currencies); sugar on pullbacks and looking for weakness to get short gold, soybeans and crude oil.

We’re rethinking the above paragraph. We think the U.S. Dollar will bottom, but not until the mid-point of the year. We’ll wait until the June currency contracts are the lead to look at making a move here. We’re still bullish on sugar long term, and are considering a short on the May contract and a long on the October contract. As for gold, we got burned selling some calls last week with only a little time left and are now looking for a new pullback to get long. $1,000 gold is coming whether we like it or not.

The opinions contained within are those of the author and are not guaranteed. Always remember, there is a substantial risk of loss involved with trading futures and options. Past performance is not necessarily indicative of future returns.

High-Flyers of 2007 May See Big Drops in '08

January 15, 2007


What goes up must come down, and the U.S. economy is certainly poised to see a slow-down this coming year. While many of the commodity markets have seen record prices thanks to a lack of supply and an increase of demand (such as grains), a slow-down from the world's largest economy will probably put quite a damper on these markets that ran out-of-control last year and could become very profitable for those traders looking to get on the short side.


Crude oil is one of the markets we see that should have a big breakdown this year. If the U.S. buys and consumes less oil, prices should fall. Reports have it that China is raising its interest rates to slow its growth, and it is also a huge importer of oil. Today oil is off about 3%, and we see it moving from the mid-$91 range down to the mid $80s, which should provide some support. We have been bearish on oil for some time as there is no reasonable reason why it has been priced so high.


Today we implemented a bear put spread on the March contract, buying an 88 put and selling an 84 put for a net debit of $1,050. Our greatest profit level will come in between $88 and $85. Our plan would be to sell the 88 on a bounce and let the 85 either expire worthless on Feb. 14 or buy it back if we think it will move back against us.


Wheat Play
We're looking at a similar trade for wheat, which has jumped 90 cents on the July contract (worth $4,500) in just three days! The old crop March contract, however, has barely budged, and we think it is poised for a fall.


March and July wheat are up about 10-cents each as we write, but are off their highs from this morning. We'll wait for a move down to jump with the flow and will look to buy a May 800 put for about $900 and sell a May 750 put for about $450 for a net debit of about $450. Like the oil trade, we will profit the most if May wheat drops under $8.00, but stays just above $7.50.


What Will Be Up In 2008?
We see a few markets that should continue their upward ways this year.


The U.S. Dollar, which has been beaten down to record lows, could make a recovery this year. We will wait, however, for the next FOMC interest rate decrease to measure how the market feels about the Dollar. If history repeats, the Dollar should drop if the Fed lowers interest rates (the Dollar will be less attractive for buyers as they will sell our currency and buy a currency, like the Euro, which has a higher interest rate). But history likes to throw curve balls every now and then, and if the economies in other countries start to slow, there could be a renewed flight to the Dollar since our down economy is already priced into the value of the Dollar.


The "soft" markets - such as cotton, sugar, orange juice and cocoa - are also looking attractive for a number of reasons unique to each product.


We like cotton because acreage is moving to other cash crops. It has had a huge increase in the past couple of days, and a pull-back should provide a new buying opportunity.


Sugar has also had a nice, measured run up and now in a side-ways pattern. We've been long the March 11-cent call for the past three months and are sitting on a paper profit of over twice our entry. We'll hold this for a few more days as expiration is closing in, but we're comfortably in-the-money and want to keep it that way. On a breakdown under 11.30 we'll get out, let it fall a bit, then get back in the May contracts at either a 12-cent or 13-cent strike.


We like cocoa also as supply appears to be tight for the rest of the year. On a sharp move up yesterday we bought a March 2200 call for $400, looking for the market to test the 2400 range and get out with a quick profit. Cocoa dropped a bit today, moving us just out-of-the-money, but we're confident there will be a push over the next week to probe new highs before this expires at the first of February.


Tomorrow we'll examine coffee and orange juice.


Have a great day, and good trading.

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.