How to use seasonals in Option Selling


Apr

4

2016

How to use seasonals in Option Selling

Michael Gross explains using Seasonal tendencies to gain advantage as a Commodities option seller
Click To Read Video Transcript

(Video Transcript)

Hi, this is Michael Gross of OptionSellers.com, here with your bi-monthly Option Seller E-Mail Lesson. The subject of this week’s lesson is a big one: Seasonal Tendencies of Commodities. Now, if you’ve read the book, Complete Guide to Option Selling, you’ll know we devote a lot of time to seasonal tendencies in this book. In fact, chapters 15 and 16 are two big chapters you’ll want to read if you’re interested in seasonal tendencies. Seasonal tendencies are one of the main things we look at when we are selecting trades for portfolios, so it’s something we’re going to talk with you a little bit about today. Let’s go ahead and jump right in to the material.

Right now, I want you to look at a seasonal chart. What we’re going to put up here is what’s called a seasonal tendencies chart. The chart you’re looking at right now is for March soybeans. For those of you who got the newsletter this month, this is one of the charts we used in there to kind of demonstrate how seasonal tendencies work. What you are looking at is a compilation of averages over 15 years. What this tells you is on average, over this period of years, soybean prices have tended to move in this general direction. Now, does this tell you exactly what prices are going to do every year? Of course it doesn’t. Market movements can vary from the averages, sometimes vary widely from the averages. Sometimes, it can move the opposite of the seasonal tendency. This is certainly not guaranteed that the price is going to move this way, there’s always risk involved when you’re trading. But, what this does do, and what this chart does, is it can give you an idea of what the averages are.

A lot of people look at seasonals, at least the people that know of them, as kind of an invisible hand, you know, this force that the day to day traders aren’t really aware of that is putting pressure on prices one way or the other. The chart you’re looking at right now is not a price chart. What it is, you’ll see the numbers on the right side of the chart are simply percentages. So, it’s telling you zero is the lowest point of the year and 100 is the highest point of the year. What the chart is showing you is the average price movement, regardless of what the absolute price of the market was. So, that’s how you look at a seasonal chart, that’s the context of a seasonal chart.

Now, let’s talk about a seasonal chart, what it is and what it isn’t. As I said, seasonal tendencies are not a silver bullet; however, as an option seller, they can be a powerful tool. In fact, one of the articles in our newsletter this month was “Seasonal Tendencies: The Option Seller’s Ace In The Hole”. I think, especially for option sellers, knowing what the seasonal tendency is can be especially helpful to you when you’re doing a trade analysis, and we’re going to talk about it a little bit now. Seasonal tendencies are one of the most misunderstood aspects of commodities. Even commodity traders, a lot of them, don’t know how to properly use a seasonal tendency.

I’m going to draw a chart here and I’m going to try and make it look like the sample one you just saw. Let’s say that’s the seasonal tendency, how it typically moves. Seasonal tendencies go all year. Let’s say, you’re looking at the soybean market, since that was one of the examples we used. Traders and investors, even some that are experienced in commodities, will look at a seasonal chart, and when they first see it, it seems like they’ve just discovered the magic key. “This is what’s really been going on behind the scenes and I didn’t know about it. This is what’s really been moving the markets. Now that I know this, I’m just going to throw all of my money into this and get rich.” Well, it doesn’t work that way.

How a lot of people look at this, and there’s even been some books written on this, people will look at the average and say “okay, on average, the thing seems to make somewhat of a low in February and then it goes straight up. So, I’ll look and I’ll find the average day it does this. Just for example purposes, let’s say it’s February 15th. On average it makes it’s high on August 1st. Again, I’m just using this as an example. So, what they say is “well, on February 15th I’m going to buy it and on August 1st I’m going to sell it, and I should be guaranteed a profit. Well, I’m sorry, but it’s not that easy. Most people that try this eventually find out its not that easy, because these are averages, as we discussed. Maybe one year it went like this, and one year it went like that, and maybe one year it went like this and then up, and maybe one year it went like that. So, you don’t know. On average, it looks like that but it doesn’t mean it’s going to do it every year. People will try and trade it that way and it doesn’t work, and they say, “Well, seasonals are no good”, so they abandon them and stop using them. That’s too bad for them but it’s very good for you, because you’re going to learn the right way to use seasonals today.

Now, the first thing I want to mention here is as these are averages – I’m going to put our sample seasonal up here again – as these are averages, if you’re a futures trader who wants to go in, and futures traders are typically trading short-term, and as we know the drawbacks to trading the actual contracts are your timing has to be pretty good. Otherwise, you’re going to get stopped-out, unless you want to risk a whole lot of money to make a little bit, which, you know, typically what you’ll want to do is risk a little to make a lot if you’re a futures trader. So, seasonals can be tougher to use as a futures trader, simply because of that timing aspect and this is averages and the averages aren’t perfect, unless you’re willing to get stopped-out a whole lot. They are helpful. I don’t think they’re as helpful to you as a futures trader as if you’re an options seller.

When you combine seasonal tendencies with the strategy of options selling, then you have a powerful combination. When you’re an options seller, you don’t care about the short-term direction, you care about longer-term trends. If you have a good seasonal in your favor, that can be something that can help sway the odds in your favor as an options seller. As we know, when you’re an options seller, that’s what you’re about, is putting all the advantages that you can in your favor, including selling deep out-of-the-money. So, even if you’re wrong, you’re not going to get stopped-out hopefully.

Let’s do an example here. The futures trader, let’s say this is a seasonal tendency, and you don’t know where the absolute price is but this is the seasonal chart. Let’s say this is our price chart. This is where it is this year, and this year it’s here. It’s a little off, but it’s pretty close to the seasonal. Futures trader would say “okay, well I’m going to try and buy it here”. Well, if he’s not right on and the thing goes down a little bit more, he’s going to get stopped-out. As an options seller, somewhere around this time of year in here, doesn’t have to be this day, this day, or this day. He’s just going to go way down here and he’s just going to sell a put down here and take in a premium. Now, if the seasonal is a little off, if it starts rising early over here, that’s fine. If it keeps going down all the way to here, that’s fine, and then it rallies, that’s okay. Maybe it goes down and doesn’t rally at all, maybe it just kind of levels off and goes here. That’s okay. He sold the put so he doesn’t have to worry about those short-term swings that the futures traders do. That’s why combining a seasonal with option selling is such a powerful combination, that’s why we talk about it so much. So, that’s the rationale from a trading perspective of why seasonals are important.

Now, I want to go back and talk a bit more about the seasonal itself because you have to understand the seasonal is just a reflection of prices averages. To really be able to capitalize on seasonal tendencies and put them in your favor because of the inexact science of them and the fact that they can be wrong sometimes, you have to know the fundamentals behind the seasonal. What is causing prices to move this direction different times of the year? What is behind this tendency? That, of course, is the market fundamentals, as we have discussed before.

Think of seasonals as just another tool in your toolbox, but a very powerful one, because seasonal tendencies tend to be reflecting fundamentals. In other words, over 15 years, a price average may tend to move up a certain time of year. Well, that doesn’t just happen magically. It happens because there are core fundamentals inside that commodity that tend to cause them to do that every year. We talked about soybeans in the newsletter this month, we talked about natural gas, in another one we’ll be talking about coming up is gasoline and crude oil. Let’s just take gasoline, for example. Demand for gasoline tends to be highest at the retail level in the summer time. Everybody’s out of school, everybody’s going on vacation, weather is nicer, everybody is driving and using more gasoline, therefore, demand is going up. Now, you would think that would cause a spike in gas prices in the summer and it does at the retail level often, however, in futures prices, mostly reflecting what’s going on at the wholesale level. At the wholesale level, that demand for gasoline is going up in the springtime. That’s because the distributors are accumulating gasoline inventory at that point.

So, that wholesale demand as distributors accumulate inventory and able to meet summer gasoline demand, is often what’s helping to support gasoline prices in the springtime. So, gasoline seasonal tendencies tend to rise in the spring. Now, does that mean it’s always going to happen? No. Does that mean gasoline prices are going to rise this spring? No, not necessarily. Does it mean gasoline prices can’t go down in the spring? No, it doesn’t mean that either. Past performance is not indicative of future results. What it does tell you is that over the last so many years, prices have tended to do that. Not always, but they’ve tended to because of that fundamental going on behind the markets. Seasonals are true in a lot of commodities markets, some more so than others, but some big ones with some strong cyclical fundamentals that tend to cause these seasonals are energy markets, grain markets, and other agricultural markets, as well. Probably less so in the metals, less so in financials. If you’re looking at the agricultural markets and the energy markets, those are two of the ones where you’ll probably want to take a pretty good look at seasonal tendencies.

The last thing I’d like to talk about today, as far as seasonal tendencies go, is when you are using them, again, they are to be used as a tool. They are not a silver bullet. They can be a powerful tool, but a tool nonetheless, because markets are a seesaw and the market will move depending on which side of the seesaw has the most weight. If you have a bullish side and a bearish side, there’s always going to be arguments for both sides. There’s always going to be bulls and there’s always going to be bears, and there’s always going to be factors or reasons why the market could move either of those directions. They are always going to be in the market. You’ll read a bullish article, you’ll read a bearish article. Crop size look huge, it’s bearish. Yeah, but there’s weather concerns and it might cut the yield down. It’s already priced in that it’s bearish and that’s bullish. You’re always going to hear those conflicting sides of the argument.

One, it’s important to know the fundamentals and which side is a little bit more important to pay attention to. When it comes down to when you’re looking at a market, you’re looking at these bullish and bearish factors. A seasonal tendency, what the tendency has been based on those fundamentals, can really put a big extra weight on one side of the seesaw when you are doing your market analysis. So, we give them a lot of credibility when we’re looking at potential positions. Again, we pay a lot of attention to the fundamentals behind that seasonal, what they look like this year, how they compare to last year’s so you don’t take a seasonal face value, but it’s a good place to start.

If you’re an option seller, I advise using that as a powerful tool. You can’t always use them, and some markets don’t have seasonals certain times of year, but certain times of year they do and, when they do, you can certainly be aware of it. If you know the fundamentals behind it you can often times take advantage of it, so that’s something you can use in moving forward. The thing about seasonal tendencies is most traders and investors, even commodities traders and investors, don’t know how to use them. The ones that do often times don’t know how to use them properly. If you know how to use them in this context, you can put them to work for you, hopefully make some money for yourself in selling options. It’s something I would recommend if you are learning how to do this.

I hope you’ve enjoyed the lesson this month on seasonals and how to sell options in accordance with them. If you would like to learn more about working with a portfolio with OptionSellers.com, incorporating factors such as seasonal tendencies, fundamentals, the other type of things we look at. I do recommend to you requesting a copy of our Option Seller Investor Discovery Kit. You’ll get a full kit that explains the whole program and how we sell options. You’ll also get a full-length video. It is free. We don’t ask for your phone number, so if you’re interested and you want to take a look in how you might be able to participate, just go on our website. It’s OptionSellers.com/discovery and request if for free. Hope you have a great month of options selling and we’ll see you next time.

  1. Joseph Hunting Says:
    April 6, 2016 at 11:42 pm

    How do you decide how far out of the money do you sell puts? Is it based on some historic volatility data around the seasonal trend? Whats the minimum credit/% return on margin requirement, do you look for?

    • Michael Gross Says:
      May 5, 2016 at 4:02 pm

      Hello Joseph,

      Thank you for two great questions.

      There is no set in stone rule as to how far out of the money to sell. We base our decision on the fundamentals (supply and demand), where the price is now compared to the seasonal average, and where we think the market is Unlikely to go. We’ll then look at what strikes are available above (for calls) or below (for puts) that level.

      As far as what type of return on margin we look for, again, no set rule. However, you can expect most futures options (of the variety we recommend here) to pay you 40, 50, 60% return on your invested margin – assuming you are paying exchange minimum margin.

      To really dig into both of these subjects, I recommend reading chapters 6 and 7 of The Complete Guide to Option Selling 3rd Edition (www.OptionSellers.com/book).

      Thanks.
      -Michael

  2. LK BARMAN Says:
    April 5, 2016 at 8:28 pm

    A TRANSCRIPT OF THE SUBJECT WOULD BE MUCH HELPFUL.

    • Michael Gross Says:
      May 5, 2016 at 4:03 pm

      Mr. Barman,

      We do transcribe many of our videos. We should have all of our tutorial videos transcribed within the next 90 days.

      Thanks
      Michael

  3. Steve Baker Says:
    April 5, 2016 at 6:38 pm

    Good presentation Michael. It would be interesting to actually see each of the 15 years plotted on a graph to see the bandwidth.

    • Michael Gross Says:
      May 5, 2016 at 4:05 pm

      Hello Steve,

      Thank you. You can see these kinds of charts over at http://www.MRCI.com. They have an inexpensive membership fee but they provide a wealth of seasonal data.

      I recommend them highly.

      Sincerely,
      Michael

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