A good — and surefire — way to get acquainted with commodities is to try out a few paper shops. So, here are some vacation home chores to try.
Commodities, unlike stocks, are leveraged vehicles with expiry dates. This makes trading them both potentially lucrative and devastating. Below are some commodity options strategies that we have offered to our brokerage clients. These are not recommendations; they are merely educational examples. If you are not privy to the risks of trading commodity options, especially if you are selling them, please do not attempt this without the help of a professional…even then it may not be a good idea.
Light a natural gas game
A common assumption is that natural gas prices will increase in the winter months as the cold drives up consumption. But the futures markets generally price in a weather premium going into the winter season; As a result, the path of least resistance for natural gas is generally lower through late December. Last year and on average, the April gas futures contract tends to find a bottom in the last few weeks of December (but front month contracts, priced much higher due to winter weather, often continue their downtrend).
On a weekly chart for Natural Gas the complex (based on front month chart) is approaching long-term trendline support. This should at least slow sales in the front months, but in the later months, like April, which are priced much lower, sales “should” slow down. Also of support is that the Freeport LNG plant, which was shut down due to an explosion earlier in the year, is restarting. Its closure reduced US producers’ ability to export natural gas to Europe to help offset Russia’s deficit. This provided a much-needed opportunity to replenish domestic inventories and put pressure on prices.
A word of caution: Momentum and thinly traded holiday markets are a deadly combination. So the bulls should approach the market with a nibble instead of swinging for the fence. A natural gas futures flush towards $4.00 in the front month contracts is possible. Because of this, those looking to play on the upside might consider the strategy of selling an April put at a strike price they would like to hold the futures contract from (we think $3.50 is an attractive price are). However, natural gas futures expire monthly, so holding the exercised futures contract would be temporary unless the futures contract is rolled into the May contract. In our view, that should probably be the goal if the opportunity presents itself.
To clarify, selling an April put is a way to fill an indirect limit order to buy natural gas futures at the short put’s strike if the option is in-the-money at expiration. The benefit of this approach is that the premium collected upfront acts as a downside risk buffer, but is a source of profit if the market turns up from here. Below the exercise price of the put, however, the risk is unlimited. This is not a suitable strategy for small accounts or risk-averse traders.
Paper trade idea: Sell natural gas at $3.50 and close to $0.33 or $3,300 in April
Total balance = approximately $3,300 less transaction fees
These options expire on March 28th with 94 days to expire
Margin = $3000
Risk = Unlimited under $3.50
Max win = 33 cents or $3,300
Pour some sugar… on paper
Sugar futures found a way to rally despite December’s mostly bearish seasonality and tumultuous crude oil prices earlier in the month. But we have to wonder if the uptrendline will reverse the rally the same way it did in November.
The daily chart for the Relative Strength Index is also showing bearish divergence. This occurs when the futures market makes a new high but the indicator does not. This may be a sign of a rally that is running out of buyers. A cheap, easy, and low-risk way to play is to play a put from 20.75. March for about 70 points or $784. This option is close to the money with around seven weeks to expiration.
Paper Trade Idea: Buy March Sugar 20.75 Put near 70 points.
Total cost = approximately $784 plus transaction fees
These options expire on February 15 with 55 days to expire
Margin = $0
Risk = Limited to entry cost (about $800)
Maximum win = Theoretically unlimited
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