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July 19, 2016 – Podcast James Cordier & Michael Gross
Michael: Hello, everyone. This is Michael Gross of OptionSellers.com, here with head trader of OptionSellers.com, James Cordier. We’re bringing you your monthly Option Sellers Radio Show. This is for the month of July. Today, we’re going to talk about quite a few things. I want to start off with the gold market, because, James, you were featured on CNBC this month talking about gold, taking a little bit less than bullish view on that. Is that still your view on the gold market right now?
James: Well, Michael, as you know, everyone’s bullish gold simply because of 0% interest rates and negative interest rates around the world. The last time that quantitative easing was introduced in the United States, that’s what raised gold from $1,100 up to $1,900. Now, a lot of investors are thinking basically along the same lines. Quantitative easing was supposed to create inflation. Several years ago in the United States, when we went to QE, it didn’t happen. Now, I believe investors are falling maybe into the same trap, thinking inflation’s on the way. Because of negative interest rates, it may not play out that way. As a matter of fact, lower prices for commodities because of a weak global economy, we think, is more likely.
Michael: That’s counter to what a lot of people feel right now because of times of anxiety, we have terrorist attacks again in Paris this month, seems to be a lot of turmoil in the world right now that’s bringing a lot of investor interest into gold. You seem to feel that the inflation argument probably will be what dictates the direction here over the longer term. Is that correct?
James: Michael, eventually it always does. Quite honestly, inflation is the catalyst for gold and silver to go higher. If we have deflation, we just don’t see how it can produce gold prices of $1,600, $1,700, $1,800 an ounce, which a lot of investors are looking forward to. But the fact of the matter is, gold did rally to $1,800 and $1,900 an ounce several years ago. Commodity prices were raging, soybeans were at multi-decade highs, so was copper, so was crude oil, so were many of the foods. We are going into a very weak economic/global state as far as demand for commodities. We have overproduction of everything from steel, to zinc, to iron ore, to copper, and silver. We just don’t see the inflation scenario taking place. Is gold good for hiding out when there are situations going on around the world? I guess it is; however, inflation eventually dictates the price, and we’re seeing probably deflation at the end of this year.
Michael: Well James, you make some good points, and maybe they’re listening to you because since your appearance on CNBC at the beginning of July, gold has had a pretty good retracement down. I also noticed, and this is something that we mentioned in the article that you did last week, that we have a very big speculative long position in gold futures. It’s on the record that with 50,000 contracts it’s pretty heavy, so oftentimes when you have that heavy speculative yet small speculators pouring into the market, they’re heavy along the market and you have commercials getting short. Sometimes that can be an indication of a trend change.
James: Michael, we think this is one of the most crowded trades ever. Just about practically everyone who’s a gold bug is double down on getting long gold. We have had a decent rally. It rallied nearly $100 an ounce. We’ve come back about $50 real rapidly over the last 2 weeks or so. Basically, the U.S. economy is doing okay. We’re not looking at negative interest rates anytime soon here. We think that the smart money, who probably was buying gold around $1,100 and $1,200, probably feels that they just have too much company right now. We see gold probably retracing into the $1,200’s over the next quarter or so. We think gold is a great market to trade. We would not be stuffing it under our mattresses… not at this price, certainly with commodities headed lower, we think gold and silver are going to probably be sold off slightly as we go to the end of the year.
Michael: Now, that brings up a good point, James, and I know you’ve made this point before, as well. When you’re talking about gold prices, or writing about it, people have the viewpoint of, “Well, what is it going to do? Is it going to go up? Is it going to go down? Where do I need to buy it? Should I buy it now?” Obviously, first of all, our listeners know that’s not really how we’re trading here or how you’re supposed to. What you can’t say on CNBC is “Look, I don’t know if this is the top, but we’ll see it going through the roof and you want to take advantage of selling some of those high option premiums.” Do you have any you’re looking at now or how would you go about trading that market?
James: Michael, we like talking about volatility and low-hanging fruit at the same time. That just took place in gold and silver the last 2 or 3 weeks. Gold is probably fair valued around $1,300, and silver is probably fair valued around $20. The gold bugs and silver bugs just came out in full force over the last 2 weeks. Silver bugs buying $40 calls for silver out several months in time, buying $1,900 and $2,000 gold calls several months out in time. We just feel that the likelihood of that happening is so minute. It simply isn’t going to happen, in our opinion. Gold production is doing quite well, as a matter of fact. A lot of investors are familiar with the fact of oil production has gotten better and more productive with fracking. There’s a new technology in the gold production. It’s similar to oil fracking except it’s in gold production. There is no shortage of gold, and as we see investor appeal go towards other markets and realize that buying gold of $1,350 and $1,375, they’re buying the top price in the last 2 ½ years and that might be a good place to be taking profits. We think that selling calls, you know, $1,900 and $2,000 in the gold market right now is going to be ideal. We think that silver and gold are probably going to be around 10-20% cheaper than where it is right now. That’s probably the best sale on the market right now is selling silver calls at 40 and gold calls at $2,000. We think that’s probably the best way to find yield anywhere right now.
Michael: Yeah, and I love that strategy, James, and I know it’s one you and I have talked about. You get so much investor interest and you get media interest and it kind of feeds on itself. That’s what brings us speculators in to start buying those deep out-of-the-money strikes. Targeting them is what you’re talking about now. A lot of investors probably aren’t aware that there are strikes available that far out of the money when you’re trading futures, and I’m sure a lot of them appreciate you pointing that out just now. Speaking of the anxiety, a lot of anxiety now coming about the election season. A big election coming up and the question I get a lot when I’m consulting with investors, and I’m sure you do too, is “How is the election going to affect commodities? How can it affect the price of my selling option portfolio?” How would you answer that question?
James: Every time we have an election, all of the smartest minds in the world trying to figure out if that is going to be bullish or bearish for the stock market. Is it going create inflation if the democrat or republican wins? This has been going on for the last 200 years in the United States. We feel what it does is it provides opportunity because it’s uncertainty. Investors will buy puts who think the market is going to fall, they’ll buy calls at extraordinary levels that think it might be bullish, and we never use the terminology at the end of the day because let’s say at the end of the year from now on. That does not change the supply and demand of raw commodities. It changes it so little that going into an election, when there’s a type of fear on the upside or downside of a particular market, you want to sell that going into an election, because when the dust settles several days later, we’re right back to supply and demand, and that never changes with an election. We don’t see that happening in 2016 either.
Michael: Yeah, that’s a great point. You get in an election year, especially right around the election, and maybe a couple days after you get sometimes a reaction in the stock market, and maybe even in some commodities, but the fact of the matter is, at the end of the day, no matter who gets elected, people are still going to eat their Corn Flakes, they’re still going to put gas in their car, and they’re still going to want their cup of coffee in the morning. The supply and demand cycle goes on, and that’s really how it affects the commodity portfolio. In the longer term, it probably won’t have that big of an impact. Speaking of coffee, you have a nice feature in the newsletter coming up this month that you put together on the coffee market. That’s kind of an example as where you get a news story or something pushing up prices against the fundamental. Can you talk a little bit about that? Just maybe give our listeners a preview of what’s coming up in that piece?
James: Michael, what’s happening in coffee in 2016 is so similar to what has happened over the last 10 or 15 years. We have several fronts right now. We have dry conditions in some of the growing regions in South America. We have free season in Brazil, which historically was a big driver to higher prices. Of course, we have a lot of investors thinking that coffee consumption has increased dramatically. These are 3 things that have pushed coffee up recently. Coffee was trading around $1.30-$1.35 a pound. It has rallied up to $1.45-$1.50 a pound recently. Historically speaking, coffee rallies in June and July based on the fact that it is free season in Brazil. In all actuality, come September, October, November, Brazil is picking beans and Brazil, like all other nations, need to turn their commodities into cash. We see very large sales happening in September and October of this year. We see that the price of coffee will likely be around $1.30 to $1.35 at harvest time and we are very much salivating over selling calls at the $2.60, $2.70, and $2.80 level. We think that coffee will be half that price this fall, and that I think is probably one of the best examples of low-hanging fruit here in the month of July.
Michael: So, it’s high right now, you think it’s fundamentally over-valued, if that’s a fair statement. You made some good points there, but is any of that based on where we are with supply right now? I know Arabica production hitting a record this year in Brazil- 43.9 million bags. Is that already priced in or is that yet to be priced in?
James: The Arabica production in Brazil this year will be a record. The Robusta production in some of the northern regions of Brazil is down this year. It’s down about 2 or 3 million bags. However, there is no shortage of coffee by any means. We did have difficult weather because of El Niño this past year. La Niña is now taking place and we think that is going to return a lot of the precipitation to areas in Columbia, Brazil, Honduras, and Vietnam. That will help production in the upcoming year. Supply is worldwide; it’s practically a glut. Here in the United States, they call something known as green coffee stocks. That is counted and announced every month. In June 2016, coffee supplies hit a 13-year high here in the United States, 6.2 million bags, and no shortage of coffee in the United States. We’re the largest consumer, and as long as there’s a lot of coffee around the consumption country of the United States, we don’t see prices getting any higher than a weather scare, which is basically what we’ve had here recently. We think this is going to be a short-lived rally. Supplies are burdensome and demand is about the same, believe it or not.
Michael: So, in short, this is almost like the ideal market we talk about in our book where you have a fundamental situation. The market, for whatever reason, rallies against that fundamental, it gets overvalued, the call options get overvalued, and we don’t necessarily now where that top is going to be, but when you know it’s overvalued you know it’s going to be there somewhere. When there’s options so far out-of-the-money, that’s a time you start cashing in on, that’s the time you start collecting premium.
James: Michael, what we’ve noticed last 12 months is that any time a commodity rallies on headline news or slight weather concerns in different parts of the world, especially in producing nations, you have investors chasing yield. It happens in silver, it happened in soybeans, it has happened in coffee recently. When you have negative interest rates around the world it sets up opportunity, because what winds up happening is investors will end up buying commodities above and beyond their fair value, they come down to their fair value after the frenzy ends, and during that time there’s a crescendo, and that’s when you sell calls on commodities 30, 40, 50% above the market. In some cases, like in silver and coffee right now, you can sell calls 100% over the value of the market. That is just ideal for option selling in our office.
Michael: Yeah, you made a point there. I want to go back to because I want to segway into talking about the upcoming newsletter this month. The front-page article we were talking there a little bit about modern asset allocation because it’s becoming kind of a hot topic in the media right now – is 60/40 – 60% stock, 40% bond, that’s what everybody is supposed to do. That’ll make you healthy, wealthy, and wise into retirement. Given the way the economics of investments are right now, you have negative interest rates, a lot of people worried about stocks, alternatives are about to get bigger. In fact, I don’t know if you’ve seen it, but there’s an ad now on TV, I believe it’s for Invesco, that they are making that statement: “60/40 is dead. The new allocation is 50/30/20, with 20% going to alternative investments.” Do you have a viewpoint on that or what type of asset do you favor?
James: You know, that asset mix is becoming more and more popular. Reading the Wall Street Journal today, they were talking about CalPERS, of course the largest investment fund in the world. They made .7% and their fiscal year ending in June there is no question that investment funds, CalPERS, and everyone down to just someone investing their $1 million account of their own are looking for return. Simply put, the stock market is going to go up and down 5% at the end of the year, it might be down 1%, we’re not sure, that’s not the game we try and play. Selling options on commodities is just a great way to diversify in our opinion. It allows investors to take advantage of bull and bear markets, the economy gets weaker, it gets stronger, and it just continues to be uncertain. That’s ideal for what we do. A 20% allocation of a portfolio into diversification, if you will, into, for example, alternative investments like what we do, I think that’s about right. I know a lot of the investors that I speak to are probably around 15-20% and I think they’re happy that they are.
Michael: James, I have kind of a personal story to share here. My mother came to me the other day and she wanted me to go with her to her financial advisor to meet with them. I said, “Why?” She said, “Well, I used to make money and now I don’t make any money.” It hasn’t grown, it doesn’t go anywhere, and she’s concerned she is in the wrong stuff. I said that I’d be glad to do that. I took a look at things and they have here in about 70% bonds, which may or may not be right for a retiree, and we’re certainly going to discuss that. I had to explain to her, “You’re in this bond market that maybe used to pay you yields, but it’s not paying any yields anymore, so that’s why you’re not getting money from it. I think that there is probably a lot of people in that mindset of, “Why isn’t there money coming out of this anymore?” It’s because of the state of where interest rates are right now.
James: Absolutely. Central banks all around the world are doing everything they can to try and increase investment and how they do that is they punish savers. They punish people who wanted to be conservative in the past, and that’s a perfect example. 70% in bonds, getting absolutely zero return and it is just not right. Why in the world savers and people who do things as they were always taught, work hard, save your money, get a fair interest on it. Why in the world do central banks around the world force you to invest in a fashion that you normally wouldn’t do is just what has taken place recently. That is what is basically changing the real value of assets. The stock market this past week has gone up to all-time highs and what is the global economy? It’s awful. Why do you think interest rates in Germany are negative right now? Because the economy is doing good? No. They are forcing investors to take on more risk than they normally would. It is creating opportunities and everywhere from commodities to stocks, a lot of investors are fearful of the stock market right now. It’s going up right now because it has a FED put under it. In other words, the Federal Reserve and central banks around the world are going to continue pumping money into the system, punishing savers, and making people invest, and that’s really a scary scenario for sometime down the line. When the stock market bubble blows, who knows, but I can’t imagine that there’s going to be a chair for everyone when the music goes off. I don’t think I’d want to be long stocks on that day. We don’t know what the stock market’s going to do the next 12 months, but a lot of the investors I speak to right now are getting a little bit fearful of it. When the stock market makes all-time highs on bearish news, you really got to think twice about what you’re doing.
Michael: Yeah, I don’t know about you, but the whole thing is starting to feel like a house of cards to me. I did a little research this weekend on that figure we were talking about, the asset allocation. There was a survey, there was a number of different big banks on here, they all add up different opinions, there’s no real consensus. They interviewed Barclay’s, Goldman’s, you know, a bunch of the larger organizations, and there is quotes there anywhere from 5%-45% of your total assets and alternatives now. I’m imagining some of those are starting to skew upwards, given the current state of affairs. We’re going to be talking about that a lot more in this month’s newsletter. The Option Sellers Newsletter for August should be in your mailbox, or at least your e-mail box, by August 1st. You should expect your hard copy probably a couple days after that. James, not to totally give away the newsletter, but there’s also a discussion in this month’s newsletter about option selling as an alternative investment, but it’s a type of account that doesn’t really… it acts like a business more than an investment. What we mean by that is a lot of people think that an investment, you buy something and hope it goes up, where a business, you get paid to sell something. If you’re explaining that to someone who doesn’t know how to sell options, it’s probably a better way to explain it. Is that how you would explain it to somebody that doesn’t how to sell options?
James: Michael, it’s interesting, so often we’ll have investors who are really astute. They’re very intelligent, they’ve been trained in the stock market, and they understand economics 101 all the way to 1,001. But, when it comes to explaining option premium selling to them for the first time, it is a complete mystery. It is so much like owning an insurance company. It’s like running a business. Basically, you’re selling to people buying. 80% of the time these options expire worthless. The insurance company probably has even a better ratio than that, but you’re basically running a business. As opposed to an asset, like Apple stock or gold, and hoping that it rallies, you’re basically running a business by selling insurance premiums to whether investors are familiar with the price of calls or puts that they should be buying or not. The fact of the matter is, we’re basically running this investment more like an insurance company. It’s been that way for the last several years and, with the uncertainty abound right now, it feels like it’s going to continue over the next 2-3 years, at least, until a lot of the uncertainty around the world gets unsettled. Premiums are much too high for the underlining value of commodities. It is a lot like running an insurance company and, as long as option buyers continue, we’ll continue selling them. It is a whole lot like taking in premiums. Every once in a while you have to pay them out, but for the most part, it’s a good place to be. It’s almost like being in the house in Las Vegas or an insurance company, depending on which scenario you want to look at. It has been interesting and it seems to be getting better and better.
Michael: Buffet says insurance is the world’s most profitable business. I think that’s a pretty good analogy. We will be covering that a lot more in the newsletter. You can look for that, again, on August 1st. James, let’s transition here and do our lesson for the month. There’s a good thing I want to bring up because we ran a series of blog entries this month entitled 7 Ways to Get Higher Premiums. It was, as you know, we discussed different ways you can get higher option premiums. It doesn’t necessarily say that we recommend all of them or we use all of them, but we talked about 7 different ways. I know you have your favorites and I thought maybe you could talk about some of the ways or some of the methods you use when you’re managing portfolios. How do you or what do you look for to target higher premiums?
James: Michael, it’s interesting. When selling options, there are many different ways described as to how much time to sell, how far out-of-the-money, what type of premiums to look for. One really easy secret that I can share with our listeners today, is that if you look at options that are 30-40% out-of-the-money and you look at options that far out-of-the-money that are 30 days left before expiring, 60 days left before expiring, 90 days before expiring, they’re almost practically at the exact same price. If that is the case, why wouldn’t you go out an additional 90 days when you sell an option? If 30% out-of-the-money a 1 month, 2 month, 3 month option is basically at the same price, go out an additional 90 days because you will get, when you initiate that short option, you will get 40-50% more premium by going out that much further in time. Yet, when it gets closer to expiration day, whether you have 1 month left on your option or 90 days left on your option, it’s practically the same price. The easy secret is to go an additional 90 days further than you think you normally would because, come expiration day, as we approach that time, you are able to cover that option 90 days left, 60 days left, 30 days left at practically the same price. So, very easily said, go out further in time. It allows you to get much more premium, in some cases 30, 40, 50% more premium, and as you near option expiration, you can cover it at 10% of what you initially sold it for. That is something that we do for our clients constantly. There are a couple other secrets. I can’t give them all away today, but, for those learning exactly what we do, that is something for you to consider. Quite often, a portfolio opens with us and they’re surprised at how far out-of-the-money we sell. Often, people think that gives the market a long time for you to be wrong. We don’t look at it that way- it gives us much more time to be right. That’s the way it has been turning out for the last several years.
Michael: James, that is a great point, one that strikes home with me because I remember back in the day, years ago, we used to debate that. You used to always say it was better to sell further out. I kind of favored selling a little bit nearer. Over time, I came to see the light. Your way of going at it, I really saw the logic in it and the years have proven that to be an astute way to approach this. It seems to give you a lot more leeway, there’s a lot more margin for error, and you get a higher premium off of it.
James: Michael, trading a lot is not what we’re interested in. Increasing high, high, high probability of option expiration is what we’re after. It all really pays off in the long run.
Michael: Yeah, and you shared your favorite strategy for getting higher premiums. I’m going to share mine, too. We’ll give our listeners 2 out of the 7 that are our favorites. This is probably one of the ones you like, as well, because I know it’s something that we do often. In selling credit spreads, and a lot of people think that protection is expensive, you’re selling an option, you take a premium, and then you’re buying that protective call or put to limit or curtail your risk, which can be a great idea. Often times, after that first few months, and those options are already well into decay, the odds of those options ever going in the money begins to drop substantially. If you can unload your protection and sell it back to the market, that brings in some extra premium for your credit spread. You just let the nakeds expire. I know that’s one you like to use, as well.
James: Michael, the time to do that is when volatility is the highest. Buying protection when volatility is low is expensive. Right now, buying protection is very cheap. Once again, it increases the odds of the trade going favorably for you. Buying protection right now is absolutely excellent timing to do that right now because of the high volatility, the high premiums. It gives us the luxury of buying protection and, talk about sleeping at night, option expiration happens worthless so often. If you can add protection to that, it just increases everyone’s odds that much more.
Michael: Excellent. For those of you listening, if you want to hear more of those strategies, obviously we recommend our book, The Complete Guide to Option Selling: Third Edition. It’s available on our website, OptionSellers.com/book. We cover those strategies and many more for getting higher premiums and protecting your downslide, hopefully building a long-term income stream. We’re going to close this month by letting you know that we do have a couple spots left for our President’s Club. I have a client group this month that’s accounts $1 million and up. Those accounts do receive some special benefits. If you’re interested, you can feel free to give us a call at 800-346-1949. Other accounts, we do have some pre-qualifying interviews left in August. If you’d like to inquire about an account and schedule an interview, you can contact Rosemary at that same number… 800-346-1949. If you’re out of the United States, you can reach us at 813-472-5760. Obviously, if you’d like more information today, you can also find out at our website, OptionSellers.com. We’d like to wish you all a great month. We’ll be updating you on your portfolio progress on the bi-weekly videos. James, thanks for your great insight this month.
James: Michael, it was my pleasure. There’s nothing that I like talking about more than short options on commodities. They’re getting more lucrative and certainly something that’s near and dear to our hearts.
Michael: All right. Well, everybody, thanks for listening. We will talk to you again next month, and have a great month of option selling. Thank you.