COMMODITY FUTURES FORECAST WEEKLY REPORT
It's Still About Oil !
Philip Gotthelf
You can debate the debates and argue about social security, Iraq, and Osama. According to The Wall Street Journal and The New York Times... and Investor's Business Daily... oil prices are driving the markets. I can't fully agree because there are many economic issues that are applying pressure that include hitting the U.S. debt ceiling this week. But, in keeping with "here and now" reporting, oil has taken front and center stage.
Of course, I was somewhat disappointed when crude took a big slide and reports trickled down about the end of the oil surge. We were just edging into positive territory as December inched to our 54 call strike price. There is good news and bad. The good news is that we could see oil stall between 5400 and 5500 through the election. The bad news is that oil's hesitancy at 5400 resistance could keep the 5400-5600 territory out of reach by the time our options expire.
Strategically, a comfortable correction might afford an opportunity to cover one of the short 56 calls for a nominal amount. We might preserve our credit while eliminating our exposure above 5600. This will depend upon the amount of any correction and the option "delta." At the same time, we are laddered with the long 57short 2x58 that was available for a more favorable 75 cents price last week. This means that we only have $1,000 exposure from 5600 to 5700 before the next call kicks in. From there, we have another 100 points to go.
Sure, oil could soar to $60/bbl. That's why traders are buying calls all the way up to $65. But, a step-back, realistic look at the statistics suggests oil will stall between 5500 and 5800 because producers are in a frenzy to sell as much as possible at the current price.
It is interesting to note that The Wall Street Journal carried a major piece on wind farms. This renewable energy source has become competitive, available, and saleable. The famous "not in my back yard" story about how the Kennedy family blocked a wind project because it was unsightly and in their back yard brought the politics into the usual perspective.
The point is that long-term prospects for oil are not as bullish as the media would like to portray. Like the California Energy Crisis, like global warming, like the population explosion, like the bio-mutation of some new virus...the list of adversity is an endless stream of "what's next?" Guess what?! The sky isn't falling, the predicted disasters have not come to fruition, and we're not running out of oil.
But, who cares? As long as the hype can influence prices, traders should be content to buy and sell fear, hope, and dismay. In fact, As crude pushes toward 5500, we may have an opportunity to build this position despite the deterioration in time on the December options.
Before today's rally (and it's not over as I write), the settlement was 29 cents on our 57/2x58. (Long December 57 call/short two December 58 calls. Note that the long (buy) leg is always given first.) That means we could lift the positions for a 46 cents profit for the week.
Profit Perspectives
Over the past several weeks, a number of subscribers have called to complain that they are losing money on the oil positions while they are listed in green (profit) on the Commodity Futures Forecast bulletin. This is because we project profits and losses on an expiration basis. The brokerage statements mark positions to market.
It was exactly the appreciation in the value of the credits that provided our opportunity to spread the 57/2x58 calls. Yes, we had a paper loss on the 54/2x56 spread. Further, that position was, indeed, listed in red to coincide with brokerage statements. But, if the spread expired Monday, we would have had a profit.
It will get worse as it gets better! Ratio spreads are one of the few strategies that you want to see getting worse! The dynamic is rather intriguing because the double short of the far calls will appreciate faster than the single long call as the strikes are approached. But, keep in mind that as the long call goes into the money, it is exercisable whereas the short calls are not...unless and until they go into the money. Hence, we want the price to go above the 54 strike, but remain below the 56 strike. This produces a profit in excess of the $400 credit we collected.
One subscriber who was anxious to be long crude oil claimed the spreads were like "watching grass grow." Indeed! He was trading a $25,000 account. Consider the approximate 4-week to 6-week holding period. Earning $400 on $25,000 is 1.6%. Multiplied by 12 months, the return is 19.2%. That's not bad when considering that the Dow Industrial average is still toying with 10,000! In addition, the $750 collected on the 57/2x58 equals 3% in less than a month on an expiration basis. Rounding to a month, it is an annual return of 36%. So, it may be watching grass grow, but the lawn is going to be very green and very thick!
By the same logic, I have heard complaints that we have held our short December corn position since the biblical flood. True, we have over 1,000% in profit, but it has been on for months. My retort is that a good position is a good position. The trend is your friend and think of all the money you have saved on commissions! I offer apologies to brokers who rely upon rapid turnover for a living, but I have had some quick stop-outs, too. It should be a balance.
October 15, 2004
Philip Gotthelf
Commodity Futures Forecast
P.O. Box 566, Closter, New Jersey
201-784-1235
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