Seasonality in Commodities and How Option Sellers can use it to their best Advantage


Mar

22

2016

Seasonality in Commodities and How Option Sellers can use it to their best Advantage

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(Audio Transcript)

Michael: Hello everybody, this is Michael Gross of OptionSellers.com, here with James Cordier for your March Option Seller Radio Show. James, welcome to the show.

James: Michael, as always, a pleasure doing this and speaking to our audience and everyone worldwide.

Michael: Well, we have a lot going on in commodity markets this month. James, let’s start off with the metals markets. We are having another surge higher here as we enter into late March. What’s going on over there?

James: Well, we started rallying here, over the last week or two, with negative interest rates worldwide. Certainly, both in Europe, China, and Japan this is the first time people have been discussing negative interest rates. That certainly gives the catalyst for investors in these parts of the world rationale to get into precious metals. Obviously, when you’re putting your money in a bank and you have to pay the bank, that certainly gets under people’s skin, and why not look for other investments? Certainly, Michael, when interest rates are negative, people think about inflation and we haven’t seen inflation yet. It appears to be right around the corner, and that’s what gold is pointing out with this recent rally.

Michael: Yeah, they’ve been interesting markets to watch. Also, over in the energy markets, a market we’ve been talking about a lot over the last couple of months – crude oil, pushing the $40 level. Where do you think we’re going from here?

James: Michael, you and I talk about seasonalities, especially in crude oil and gasoline. We’ve been trading these markets for over a decade. In regards to seasonality, one of the most ideal setups right now is taking place in energy. We are looking at perfectly fairly priced oil market, based on both supply and demand. We will often see energy prices fall October, November, December, going into what we call “shoulder season”. Then we expect this seasonal rally as driving-season approaches, and that’s exactly what’s happening now. So many people are pointing toward OPEC getting together and cutting production, and, actually, this past week they didn’t do that. They simply froze production at what level? The highest level ever. Yet, crude oil rallies $15 a barrel and gasoline rallies 20%, simply on seasonalities, and I think that’s what’s going on right now. Certainly, here in the United States, we have crude oil supplies at all time highs. You have Russia, Saudi Arabia, Iraq, and Iran producing the most oil ever, and yet the market rallies. This is the power of seasonality and it’s certainly flexing it’s muscles again this year.

Michael: Well, I’ll say in a big kind of way, and bringing up seasonals, this is a very active time for seasonals in commodities. We’re going to talk a lot about that today, simply because we’re entering into a time period here… April, May, where you have a lot of strong seasonality in a commodities markets. James brought a great one up, crude oil… perfect example. We also have some strong seasonals in the grain markets this time of year, and even over into softs markets in coffee. Coffee is a highly seasonal market as well. Grown in Brazil, their seasons are opposite of ours. Where we’re having spring right now, they’re having autumn. James, I know coffee is one of your favorite markets to trade. What’s going on right now? First of all, let’s talk about the seasonal. What’s the typical seasonal for coffee this time of year?

James: Generally, the seasonal factors have switched to demand for this time of year. Fourth quarter and first quarter, in the Western Hemisphere of course, is the largest demand season. It’s thought that people drink a lot more coffee when it’s cold, and down here in Florida, I think we drink the same amount, but certainly the populations, northeast especially, and also regions in Europe, it’s thought that someone drinks 150% of the coffee they do in the winter, versus the summer. Generally speaking, demand is largest in the United States in January, February, and March. That often kick-starts a bit of a rally in coffee prices. That’s what we’re seeing right now. Harvest in a lot of the Central American countries and Brazil, as well, isn’t in earnest at this time of the year. We’re looking at that starting in the next three to four months. Then, supply comes on at the same time that demand weakens, and that’s why this seasonal, that we’re going to talk about right now, is going to be in play probably in the next thirty to sixty days.

Michael: … And from the seasonal charts, it looks like we get a pretty steep drop off in coffee prices, at least historically speaking. We typically see that at the end of our spring, sometime in the April-May time period. Is that a function of harvest beginning?

James: That’s a function of the end of demand season and a function of the beginning of harvest season. It’s almost the perfect storm for coffee prices. Generally speaking, demand has sapped a lot of the supply once winter is over. At the same time, we’re looking at big production in most of the Central American countries. Vietnam right now is thought to be sitting on the largest stockpile of coffee ever. Brazil is going to be producing upwards of sixty million bags this coming year. Once we get past the flowering season, once the flower turns into a cherry, and once the cherry is in good shape in Brazil, you can start counting coffee bags. Right now, we’re looking at a record for 2016-2017. Seasonally, ideal situation for the market to fall off again this year, starting April and May and the low of the years, normally made in June and July, and that is something we’re certainly going to be positioning for going forward.

Michael: Record crop out of Brazil is a big story. Coffee, I know, could be one interesting development here that you mentioned earlier, before we started the show here. We have report of some type of bug in the northern part of the coffee crop from Brazil. What’s going on with that?

James: That is correct. Certainly, El Nino has produced certain weather conditions in coffee crop, sugar crop, cocoa crops, all around the world. The Brazilian coffee crop is no different. The regions that are experiencing this bug that’s been eating some of the cherries is in the northern fringes of the coffee plantations in Brazil. It’s primarily where the Robusta coffee is produced, not the Arabica. So, it’s not so detrimental to the coffee production this year, as if it was eating the cherries on Arabica trees. It’s not doing that. So, that will dent probably a couple million bags of production in Brazil this year. Fortunately, for someone who is going to go along with this seasonal play that we are going to be doing, the Robusta crop we probably can afford to lose a couple million bags, because the Robusta is what’s grown in Vietnam, and they’re sitting on stockpiles as high as you can see. We will not be short of Robusta coffee this year. As a matter of fact, we have quite a glut.

Michael: James, one thing I was thinking, as well, is you get a news story like that where the media grabs it, you bring speculators into the market. That pushes up the volatility one the options, especially the calls, wouldn’t you think?

James: Exactly, that’s playing into our hands perfectly. We’ll see, in fact, if it does play out that way. Once again, just like we have seasonalities in grains here in the United Sates for planting season, there is a seasonality for coffee prices, as well. They normally have a bit of a rally in either the months of March or April. Low and behold, here we have a rally going on right now. Primarily, it’s from the dry condition in the northern parts of Brazil. Also, this bug has been hungry for cherries recently, and who can blame it. I would be too. What a beautiful cherry to ravage, and that’s what it’s doing. It looks like it’s going to possibly reduce this year’s production by a million or two bags. We don’t think that’s going to make a big difference come harvest time.

Michael: And as far as strategy goes, we have a market now coming into a time where typically it has a bearish seasonal. We have somewhat bearish fundamentals, this strategy we probably look to do there would be put together some type of call selling strategy. What do you see there, James?

James: Well, quite often, a lot of the markets that we’re following right now are fairly priced. However, coffee is not going to be fairly priced. We’ve been trading around 130, 133 recently. If, in fact, the market gets up to the mid to upper 130’s, possibly 140, that will be above fair price. That will be above fair value. That should spur call buyers in coffee all the way up to the $2.40-$2.50 level, practically double the price of coffee. If we time that to sell these options to expire in fall and winter, later on this year, we’re expecting coffee price to be back down to the 120-125 level. If we’re short from $2.50-$2.60 strike prices in coffee, ideal for a seasonality and ideal for option sellers over the next 30-60 days.

Michael: That’s a great point, and, if you’re listening to this, coffee is a great market to trade fundamentally and one of the big advantages if you’re an options seller. If you’re trading in this market, there aren’t a lot of traders out there who understand the fundamentals behind this market. They’re trading it technically, they’re watching the news, but if you understand the fundamentals in markets, especially like these- coffee, where you don’t have a lot of mainstream media coverage, it can be an advantage to you as a trader, especially if you’re selling deep out-of-the-money options. So, that’s one of the things we try and bring you here. James, there’s a lot of seasonals this time of year. We can’t cover all of them in just this podcast, but grains are a market that has a lot of seasonals in the spring. Corn is one market that we covered earlier this month. If you got our e-mail, you get our monthly e-mails on the markets, we did feature the corn market, we’re also getting some volatility there. Let’s start off talking about corn, James. We have a seasonal, tends to go down once we hit March-April. Can you talk a little bit about that?

James: You know, the seasonality for grains, corn and soybeans, grown primarily in the Midwest, here in the United States, generally we have an idea that it’s too wet, it’s too dry for planting season. It can be either delayed, it can be the ground is simply too dry from the previous year. It seems to have a rally as we go into the end of the first quarter. We’re getting a small rally right on the grain market, and that might be primarily what’s happening right there. We expect, with corn supplies at ten-year highs, we have carryover one of the highest in almost two decades. We expect corn prices to probably head back down in late spring, early summer. Certainly, with supplies as large as that, corn is going to have a difficult time reaching some of the levels that we can sell corn calls at. Any strong move to the upside here in March or April would be ideal for selling corn calls for the end of September, October time frame. That’s something we’re going to keep our eye on, certainly. As you know, Michael, the best thing about selling options on commodities, it’s purely supply and demand. There is nothing technical that creates a bull market, there’s nothing technical that creates a bear market. It’s simply having not enough of the commodity to go around, or there’s too much of the commodity to go around. That causes prices to fall. At the end of the year, the weather is not going to be an issue, the technicals are not going to be an issue, the United States is going to be flooded with Corn. That is going to be meaning lower prices and corn calls purchased by those who buy lottery tickets, as you like to describe them. I think they’re going to be throwing them out the window, because that’s what they’re going to be worth this fall.

Michael: Yeah, I agree with you, James. In corn you have a market similar to coffee, where you have a strong seasonal tendency for prices start to break right into planting season. Interesting conversation this week with Jerry Toepke with Moore Research, who is going to be featured in our upcoming April issue of The Option Seller. Jerry plays a big role in building those seasonal charts we all see online. We were talking about the corn market and corn’s one of those markets where, just as you mentioned, sometimes you get some anxiety building up to planting season. Once the crop starts going into the ground, corn tends to go in a little bit earlier than soybeans, they tend to finish up a little bit earlier than soybeans. That anxiety starts coming out of the market, price starts to break. So, you have a strong seasonal tendency for this to happen, and we also have, on top of that, some bearish fundamentals. It’s hard to state them any other way. You have corn stocks at 10 year highs- 1.8+ billion bushels. Planting intentions are expected to be 2 million acres higher this year than they were last year. At the same time, we have some things putting a little bit of volatility into the market. You have the anxiety over planning coming up, there’s some talk of some wetter soil levels in southern growing regions, and we also have the USDA planting intentions report that comes up on March 31st. We’ll get a little bit more refined picture of what planting is expected to be this year. Right now, they’re expecting it to be higher over last. Two things- you have bearish fundamentals and a bearish seasonal, so any one of those things that brings more volatility pushes call prices up, unless there’s some type of real challenge to planting this year. I agree, I think we’re going to have some great call selling opportunities there. It’s a market to watch.

James: It sounds as though we’re piling in on corn, but the fundamentals don’t lie- the numbers are true. Any excitement or pandemonium over weather conditions this spring is going to create a great selling opportunity. Hopefully, we get that excitement in volatility, and, if we do, laying out calls is going to work real well, I think.

Michael: Yeah, I think so, and soybeans are in the same boat to a certain degree. We’re going to be talking about them later in April. The point there is they’re a great time to trade grains this time of year, certainly a market to keep an eye on. As I mentioned, coming up in the April newsletter, you will hear my interview with Jerry Toepke of Moore Research- some great insights into seasonals. We’re also going to be featuring the coffee market, one James just talked about here, spell that out a little bit, and show you a strategy you can potentially use there, depending on where we go. While we’re talking about seasonals, James, I thought we’d go ahead and move in and talk a little bit more about how traders can use seasonals, because I’m sure a lot of people listening they’re saying “What are seasonals? I’ve heard of them. Maybe I’ve never heard of them at all”. In commodities, there are seasonal tendencies of certain markets. It’s not guaranteed, but they can be a powerful tool to use, and we use them here extensively. I think they are a very important part. James, maybe it would help some of our listeners if you talked to them a little bit about how you use seasonals. What’s the type of thing you look for in a seasonal chart when you’re looking at these things?

James: Michael, quite often, commodities are fairly priced. Each day, when the bell rings on the exchange floor in New York and Chicago, the price of corn, the price of coffee, the price of gold, trades at exactly the level it’s supposed to be. Fair value. We decide that by auction, open outcry, that anyone can vote on at the end of the day, and that is where the market settles each day. For certain reasons, technical trading takes place, speculators get into the market, sometimes it’s fundamental selling or buying. The idea of trading seasonally is it reverses what inevitably is an incorrect rating. In other words, the market is falling in crude oil again this year. We are sitting at $27-$28 a barrel January and February, and everyone in the world is betting that oil is now going to $20 a barrel. Watching CNBC, watching Bloomberg, watching Fox, one talking head after the other is talking about $20 oil, $18 oil, $10 oil. That sets up the perfect seasonality for what we do. Going into January and February is when supplies are at the largest and when demand is at the least. Low and behold, what do you do? You start selling puts for the June-July time frame. Why? Because the seasonality kicks in in March and April in the United States, and that is when the beginning of driving-season happens. Seasonality allows you to define how you should be positioning yourself in the market. You don’t listen to the noise trading seasonally, you don’t get excited when the market’s at it’s high, you don’t get scared when it gets to the low. It gives you the intestinal fortitude to trade commodities, and if you allow the 82% of the time when options expire worthless, that gives you the rationale for getting yourself in the market when listening to the pundits on TV would make you fearful of doing so. Seasonality gives you guts that you need, seasonality gives you the idea that, in fact, the market is eventually going to come around to your thinking, it gives you the timing that’s needed. Trading commodities, even though we don’t need great timing selling options, it’s just one more piece to the puzzle to put the odds in our favor, in my opinion.

Michael: Yeah, that’s a good point. It’s one piece in the puzzle, and, if you’re thinking about trading seasonally, these can be a powerful tool, but you can’t just look at them and use them in a vacuum. One of the things you have to understand about seasonals is there are fundamentals that tend to cause these seasonals every year. They don’t just happen on their own. So, if you can look at the seasonal that will reflect it, but to really get the most value out of it you have to understand the fundamentals behind that seasonal. James, I know one thing you do is you keep an eye on and monitor those fundamentals. Are they happening the same way they tend to happen each year? What’s different? You brought up a good point about coffee- there’s a bug in the crop. Could that have an impact that could override to seasonal? Right now we’re thinking no, but it’s still something that you have to keep an eye on, you have to understand what’s driving that seasonal to really get the most out of it. The seasonal is really reflecting what’s going on under the surface. Do you agree with that?

James: Michael, we follow around 8 or 10 commodities. As seasonals start approaching, we do nothing but analyze fundamentals, we research what the fundamentals are. Quite often, going into a seasonal period, the fundamentals will be, once again, fairly valuing the particular commodity. Certainly, when oil made a low in January and February this year, there was every reason to be bearish on the market. The thing is, we go from the least demand period to the highest demand period in a very short period of time at the very beginning of each year in the United States. We go from the smallest amount of demand of energy to the largest amount of energy usage from January to April- very short period of time. The fact that we’re trading options on futures, the market doesn’t wait for that demand to increase. It expects it to. Low and behold, April, May, and June, people start driving their automobiles, and demand goes up from 20-30%. This is what spurs this seasonal to work. It is a fundamental factor that makes the market go. Knowing these seasonals in advance allows you to get in when everyone’s selling, get short when everyone’s buying, and that’s what makes this just a great piece to the puzzle… utilizing seasonality and adding it to your option selling.

Michael: And as an option seller, if you are selling options, the reason we stress them so much is they’re almost a custom made tool for this type of strategy. It used to be, 10-20 years ago, there was a lot of talk about seasonals and commodities. The way people would try and trade them was “Well, let’s see. The chart here says the seasonal falls on April 20th, so we sell it on April 20th, and we buy it on June 1st, and that’s worth 12 of the last 15 years”. So, they go and do that. Low and behold, the thing goes up and they lose. So, the thought process is “Well, seasonals are no good. These things don’t work”. What people don’t understand is these are merely reflecting averages. It doesn’t mean it’s going to fall right on that day. It might not fall at all. The key thing as an option seller is you don’t have to be guessing what the market’s going to do on a daily basis. All you need is that general, typical price trend that you can look at, and then sell deep, out-of-the-money options, way above or way below it. So, even if it doesn’t happen at all or you missed it by a week or three weeks or a month, as an option seller you have so much room to be wrong that you can still end up profiting from it at the end of the day. I know that’s something we try and look for a lot of the time in our trading.

James: Michael, whether our audience today is selling options for themselves or they’re considering selling options with us, or they already are, fundamental analysis on the grain market, the softs market, the energy market, it’s available to anyone. All you have to do is go online, you can find out what the supplies are, you can find out what the trends are in production. Make sure, going into a seasonality, that everything is neutral. Make sure that there’s not an underlining factor that’s going to cause the market to not trade seasonally. It’s something that we work on all the time. Our listeners who possibly are selling options on their own, you can do the same thing. Don’t simply look at a seasonal chart. Do the fundamental analysis prior to getting into the market. That’s going to put the odds in your favor, something we’re always stressing. It’s not that tough to do.

Michael: For those of you who’d like to learn more about seasonals, we do cover them extensively in our book, The Complete Guide to Option Selling, 3rd Edition. They are a big component of selling options on commodities, if that’s an investment you’re looking at getting into on your own. Obviously, for our clients here, we monitor and do that for them. Speaking of, we do have some consultation dates still open for April for anybody interested in possibly talking about an account. Feel free to call Rosemary at the 800 number: 800-346-1949. She’ll let you know what we have left available in April. James, I know you have another video coming up this month. Is that correct?

James: We’re going to be talking about one of our most near and dear commodities, KC, also known as coffee, probably one of the best seasonalities available in all of the market. I’d compared it to the seasonality in energy. Supplies in coffee going forward are going to be heavy to the market, and this rally that we’re getting right now in March and April, I think, is going to set up, ideally, for seasonal call selling. So, that’s something we should probably hit in this video and get everyone very well on board as this trade approaches in the next 2-4 weeks.

Michael: Yeah, that will be a great video. I know we’ve gotten some e-mails and people are certainly interested in what we’re doing in metals. We’ve been mining a lot of premium there in the gold and silver markets, and I’m sure you’ll be talking about that, too, possibly in the upcoming video. That will be before the end of March. You can look for that in your e-mail box. You can also be looking for the Option Seller Newsletter. It should be to you sometime within the first couple days of April. I appreciate everybody listening today. I hope you found this podcast on seasonal tendencies interesting. As always, feel free to give us a call. If you’d like to learn more information, get a discovery pack, you can also find us online at OptionSellers.com. Thanks for listening, everybody, and have a great month of trading.

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