Season for Energy Trades

September 3, 2007

With Fall approaching, now is the time to look at the energy markets for some quick, short term swing trades. The crude oil, RBOB gas and natural gas contracts tend to be very volatile at this time of year, fueled mainly by the devastation hurricanes cause in the Gulf of Mexico and the Gulf coast.

Often, just the threat of bad weather will send energy futures climbing. But, just as prices soar at threats of production shut-downs, they also drop back very quickly when the pipelines start working again.

Swing trading these markets is not for the faint of heart. First, they move very quickly, often overnight, which means your protective stops may get run over and you're out a lot more money then you had planned on losing. Second, they're very expensive. Margin on one crude oil contract is $4,000. RBOB gas is $6,075 and natural gas is a jaw-dropping $10,125!

You can, however, get into the energy markets with mini contracts: oil is $2,025; RBOB is $3,375 and natural gas is $2,531.

We also like to use out-of-the-money options with strikes at areas we are looking for the market to turn. Yes, in volatile markets options tend to be expensive, but we also prefer them for money-management as our maximum loss will never exceed the price for the option.

As I write this, hurricane Felix is moving on a path just south of where Dean hit, and should cross the Yucatan and into the Gulf of Mexico on Thursday. Two weeks ago when Dean hit the Gulf, most of the Mexican oil pipelines shut down. As Mexico is one of the biggest exporters of oil to the U.S., we saw a drop in crude oil inventories with the Aug. 29 report. This caused oil futures to jump almost $2.00 per barrel that day, and prices are still hovering at their highest point since the second week of August. This map from the NOAA (http://www.nhc.noaa.gov/refresh/graphics_at1+shtml/205025.shtml?5day#contents ) show that the eye of Felix may not cross back into the Gulf, and it may weaken substantially. Our strategy here would be to short crude and RBOB futures or buy put options on oil and RBOB.

For crude oil, I like the Dec. 69 puts. $69.00 seems to be a good support level for Dec. crude, and prices quickly fell to that level two weeks ago when Dean proved to be not as devastating to the oil infrastructure as first thought. Remember, though, that the supply from Mexico will still be slowed, and the next week (after the API/EIA energy stocks reports come out on Wednesday) oil could see another big up-move. Protective stops are an absolute, and if you get a profit at your goal make sure you cash it in quickly.

We could also do the same trade with the same plan with RBOB gas. Using the Dec. contract we would short with a goal at 1.82, or buy put options with a 1.82 strike.

With natural gas, we're staying on the sidelines for now unless a hurricane moves deeper into the Gulf and threatens the Texas and Louisiana coasts. Also, reports show that we're sitting on record inventories of natural gas, and that's keeping prices at extreme lows, in the $5.34 area. Here's a link to Platt's, a company that publishes some great analysis on the energy markets: http://www.platts.com/Oil/Resources/Futures/index.xml .

We will keep an eye on natural gas, and look at the Dec. '07 or Jan. '08 for a possible call option trade. We'd be looking mostly at Jan. in the $9.00 to $9.60 strike range as many articles hint that natural gas could run back to the $10 area if a big storm hits the Gulf coast states.

OJ Update:

We still think buying some OJ calls will be a money-maker if Florida gets threatened by a big enough storm. Soon after our last post, a new report came out saying the OJ crop will be much larger than forecasted back in the spring. That sent futures prices back to their lows of the year. We'll keep watching this trade for the rest of the month. Nov. 160 calls are now at .50, or about $75 each before commissions. The Nov. 140 calls at now 1.55, or about $230 each, and that may be a more realistic goal as the contract is trading at 118.

As we write this, there is a possibility that a tropical depression is forming off the north east coast of Florida (refer back to the map above). We will keep a close eye on this.

Bill's Soymeal Recommendation:

I apologize that I haven't done more in talking about Bill's soymeal call option trade from the last post as my vacation got in the way. It has been a very fruitful trade for those who got in: the Jan. 250 soymeal call options have better than doubled in price to $12.85 as of this writing.

Wheat Poised for a Tumble?

I'm getting real excited that the wheat market is getting ready for a huge drop. It's sitting on record highs ($8.00 per bushel for Dec. '07). The last time wheat hit nosebleed altitude (back in mid 1996) it quickly dropped like a rock, making thousands of dollars for those who were short. I started to pick up some Dec. 6.40 put options late last week. Why the options? Because there is still a chance I'm jumping in front of a fast-moving train. There is still a lot of fundamental supply issues that could keep wheat at high levels, and the market has a habit of gapping up and moving over 20 points a day (each point is worth $50 - so that's a $1,000 this contract can move without batting an eye).

As I write this Monday evening, wheat has gapped up over 20 points and will likely continue to test its highs on Tuesday. Keep a close eye on this market: there are a lot of hedge funds who are long wheat, and another drop in prices could see them dumping their contracts and pushing prices back to the $6.00 level, which on the charts look to be a reasonable support area.

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.