Fall Seasonals “Ring the Dinner Bell” For Option Sellers


Aug

24

2018

Fall Seasonals “Ring the Dinner Bell” For Option Sellers

Click To Read Video Transcript

(Video Transcript)

Michael:

Hello everybody this is Michael Gross of OptionSellers.com here with James Cordier. We’re here with your August 24th OptionSellers podcast. The title of this month’s podcast is “Fall Seasonals Ringing the Dinner Bell For Option Sellers” and we have got quite a program for you today. This month we’re going to talk a little bit about some of the strong seasonal tendencies that come into play during the fall, and believe it or not we are entering autumn now and that is a big time for commodities. James welcome to the show, what are your comments on fall seasonals?

James:

Thank you Michael, always great to be here. Seasonalities are happening all quarters of the year, but it seems like the fourth quarter, as we approach those, we have very strong seasonalities in energies, which is certainly a huge market whether you’re in commodities or you’re just following stocks, and the other seasonal that takes place in the beginning of the fourth quarter is in grains and certainly what happens starting in September and October usually dictates the remainder of the year and there’s usually very good opportunities in both oil and in corn and soy beans.

Michael:

Yeah those underlying fundamentals like we talk about in The Complete Guide to Option Selling are what really drive those seasonals and we’re going to get into that here in a little bit. James before we do that why don’t we talk a little bit about stock market obviously we’ve got some headlines over there this week with, all over the news you have the Manafort Cohen story and how it’s going to affect elections and yet here we see the S&P at all-time highs yesterday. What are your thoughts on that going forward?

James:

Michael it’s really interesting just absolutely nothing has been able to stick against the stock market. Some things that came out in the last 24 hours you would think would spill the market just slightly, would slow down this Trump administration a rally if you want to give him or the administration some of the credit you certainly can and yet what takes place after these court rulings over the last 24 hours doesn’t seem to be able to stop the market. If you look abroad you have the Asian markets sitting ponderously close to a four year low. The Shanghai market is down over ten percent it’s reached more than correction territory and over in Europe the market’s just barely higher versus over the last 12-24 months. The U.S. stock market just continues to simply march to the drummer of its own beat and it seems as though while you look at Asia you look at Europe, generally these markets go in the same direction and for the first time in many years that we’ve been following stocks they have certainly switched to their own direction and as long as the stock market continues to defy gravity I guess people will continue to push markets higher, stock buyers still enjoy the fact that earnings right now are still quite strong though not as much as some people had hoped but defying gravity, as far as the rest of the world’s economy, which in some cases is slowing down and yet the stock market continues to rally. It does feel that it wouldn’t take much for some PROFIT? to come into this market. The investors that we speak to all of them who own their own companies run their own businesses, you know, are very, very successful, they’re basically not even in this market and they certainly don’t want to buy it at this level. It will be interesting to see how much the funds can continue to push it up in this direction.

Michael:

Yeah that brings to mind you have a good piece in the upcoming newsletter this month about stock market and what it chooses to focus on. It’s hard to make sense of it and the topic of the article is “Commodities Least Make Sense” you have supply you have demand you can look at those things. But, I heard an interesting discussion on CNBC this morning and they were saying that with all these things going on the market chooses what to focus on stocks are choosing to focus on the economy right now. Would that change in September when everybody comes back from vacation and gets down to business? I don’t know if I’d want to buy it here but it’s certainly been an impressive rally here at least since February.

James:

Michael it certainly has. Generally the stock market is forward looking, anywhere from 6-12 months and the more you read articles about people talking about the global economy, something that just came out was there’s like a 50% chance of a global recession in the next 5 years, it seems as though the investors still pushing stocks higher are trying to kind of thread the needle whereas we still do have a good momentum in the U.S. economy and yet once the music stops they’re planning on jumping out before that happens. This will definitely be an interesting next 6-12 months as buyers in U.S. stocks continue to pile in with the idea that they know they have to get out relatively soon with the rest of the global economy definitely cooling off in both Asia and Europe, but in the meantime, good for them. As far as the market continuing in the upward direction it looks like it’s still in place but some things very interesting to watch I think as Asia continues to be more soft European stock markets not doing very well. How long can the U.S. economy and stock market defy gravity? I would say the first and second quarter of 2019 might be really interesting to see how that plays out.

Michael:

Alright and I don’t want to spend too much more time on stocks because James and I don’t trade stocks of course we focus on the commodities. So James you and I really don’t have to worry about any of this although we do watch it fairly closely because of its impact on the global markets. However, a point I wanted to bring up a lot of the people when they call in and they talk to me or you, a lot of them are stock option sellers and what I’ve been hearing lately is “You know, I’ve been having a great 3 years or a great 5 years, I’ve been doing well, except for January.” Well January is when stocks took a nose dive and that seems to be the plate of the stock option seller is you’re going to do well typically as long as the market is doing well. But what happens when that market turns around like it did in January? I talked to a guy the other day and if he’s listening he’ll know who he is but he was telling me he made $900,000 selling stock options in 2017 and in 2018 in the month of January alone he lost $1.5 million. So, for the stock option sellers thinking well why should I possibly diversify into commodities, there’s your number one reason. Commodities are going to give you 8, 10, 15 different uncorrelated markets to sell options, where if you’re selling stock options you’re in one market and if we get a January it’s probably not going to be a very pleasant time for you, and I know that’s something you talk about often James.

James:

Michael, being uncorrelated in the stock market is what almost all of our new investors tell me as we have new account calls before we start investing for their accounts. And, the whole idea is the stock market you’re basically long all the sectors all at once, you can be in banking, or tech, or energy but they do go in the same direction, they vary from time to time. But for the most part, being in energies and the foods and the metals, does give you that diversification. Does it necessarily beat the S&P every single time we’re investing for clients, not necessarily, but for investors looking for uncorrelated investments, selling options on commodities, not only allows us to be in several different sectors but it also allows us to plan for and position for a global slow down if we do have a stock market that finally turns over, if Asia continues to have a bit of a head wind with the direction of this economy we can position that way. We aren’t necessarily long all these commodities we’re often either strangled thinking that they’re fairly priced or sometimes we are actually short the market thinking that a slow down in China or Europe might start influencing certain commodities and diversified we are, it’s certainly a great opportunity for a lot of investors to possibly get into investments other than stocks. Certainly investing is very personal but for those looking for diversification whether you’re selling options on commodities on your own or with a firm like ourselves you certainly know the uncorrelated diversification that it gives.

Michael:

Okay, well let’s talk about some of that uncorrelated diversification. The title of our podcast today is “Fall Seasonals” we’re going to give our listeners a couple of examples of markets they can sell options in possibly during the month of September and take advantage of some of these more pronounced fall seasonals. James you mentioned energy markets and grains as two of the markets with pretty substantial seasonal tendencies in the fall, however, what we’re going to talk about today are markets outside of that rim over in the softs market and the first market we’re going to talk about is the U.S. cotton market, which has a strong seasonal tendency, tends to trade lower mid-year into the end of the year into December and cotton’s got a little bit of a different dynamic this year do you want to talk a little bit about what’s going on there this year?

James:

Michael so often when investors and commodity traders are looking at cotton they’re looking at west Texas weather and west Texas in 2018 has had quite a deficit of precipitation and in many cases a lot of the largest producers of cotton this year had very little crop, if any. But, the fact of the matter is cotton is produced in over a dozen countries, very large producers around the world. Of course in the southern delta in the United States a lot of cotton is produced as well. Basically, in May and June of this past year the very hardest hit areas in Texas were very well advertised and the prices started making highs in May and June this year and as cotton bales start being counted it doesn’t look as though we’re going to have a short fall this year. As a matter of fact we’re going to have cotton supplies, at the end of the year, at the one of the highest levels in over a decade. We do like the idea of being short cotton calls going into the end of the year and generally speaking weather rallies in cotton are very similar to other markets as well. There’s a lot of insurance being purchased at the very darkest days of what the weather seems to be and then at the end of the growing season we have cotton sales from states and countries that did quite well and at the same time you have a down turn in demand usually in the third and fourth quarter of this year and that seems to be shaping up in cotton for the last quarter of 2018.

Michael:

Yeah that west Texas drought was really taking up the headlines for a good part of the year and you brought up a good point everyone was focused on that and yet when they started adding up potential stocks it turns out the rest of the country had almost ideal weather. So, ten year of highest ending stocks in ten years we’re at 4.6 million bales, that’s probably going to help that seasonal a little bit into the end of the year. The seasonal typically, what helps it along as we go into that fall harvest season, as you talked about that’s when supplies are highest and often times that’s when supplies fall to their lowest levels, if we’re here the highest ending stocks in ten years that’s probably not going to be supportive to cotton prices, but we also have something in the news maybe adding a little bit extra pressure on cotton this year and that’s what’s going on with Turkey right now.

James:

Michael it certainly is. I think what’s going to add pressure to the cotton market based on supplies later this year is you know Turkey is one of the largest importers of U.S. cotton and that is simply not going to be taking place in the coming 90-120 days. The trade dispute is not just jaw-boning it’s real and if we’re not shipping a million or two million bales of cotton to Turkey this late part of the year, that could bring cotton down another 5-10 cents a pound, which is definitely going to bring it to levels that you certainly don’t quantify as tight supplies or strong demand, you’re just going to have an average five year price probably at the end of the year, and it will be partly to blame on the Turkish negotiations and the lack of import that they’re going to be taking of U.S. cotton bales.

Michael:

Alright, now as a trading strategy, I know we don’t talk about our specific strategies we’re using in our privately managed accounts, but for self-directed traders, you’re suggesting they take a look at the March call right now is that correct?

James:

Yes, the March calls is probably a very good time frame it’s in that 6-7 month time frame and the fact that cotton at .95 cents when we’re trading in the low 80s looks like an ideal strike price is what I would be looking for. If you can sell cotton above the 95 strike price I think just that much more gives more of a higher probability for your cotton sale. We don’t recommend specific numbers but above .95 cents with a supply figure that’s going to be near ten year highs looks like a really prominent investment later this year.

Michael:

And for those of you listening, for this type of analysis, again we’re not trying to predict exactly what prices are going to do, we only have to project what they’re not going to do and what James is saying is, it doesn’t look like what he expects to be pressure on prices. Prices are going to be able to climb to that 95 or above level and thus strikes above there selling strikes above there and taking the premium should be good investments. Especially, James, looking at the margins on those you and I looked at this week, it looks like about a 43% return on equity if those calls expire worthless, so in six months that’s not too shabby.

James:

Not too shabby at all. That’s another thing that a lot of option sellers on stocks are very interested to see that the ROI when selling options on commodities can be really favorable and selling cotton and having a 40 something ROI on a position that has really high probability certainly is attractive.

Michael:

Alright, and if you’d like to read our full cotton research report it is currently available on the blog this week, it’s OptionSellers.com/Blog. Also, mentioned earlier we were talking about seasonal tendencies, we devote two full chapters to seasonal tendencies in The Complete Guide to Option Selling (3rd Edition). That is available on our website now at OptionSellers.com/Book, you will get it at a discount there to Amazon or the book store. James let’s move into our number two market this month. This is one of your all-time favorite markets, that is the coffee market, and what we’re seeing, another strong seasonal tendency lower, into the end of the year. Do you want to start with that talk maybe a little bit about this seasonal and why it tends to happen this time of year?

James:

Michael, the coffee market is near and dear to our hearts. We have been selling options mostly on the call side but also on the put side for years, in everyone’s favorite drink. Generally you look at the months of October, November, and December, if Brazil, namely, has very good moisture and they usually do, you can bet on an extremely large crop. Last October and November, Brazil just had a deluge of rain just as the right times and basically that is going to create flowering that takes place two and three and four times, that’s what happened last year. We are now in the midst of a harvest in that area we’re probably wrapping up in the next 30 days, and we would look to see harvest pressure, take that market lower, some 60 million bags of coffee are likely going to be harvested this year from Brazil, at a time where U.S. stocks are approaching a 15 year high. So, like you mentioned Michael, where’s the coffee going to go, it’s likely going to kind of surpass any type of demand and that definitely has coffee in the down trend. What we do like is as we do reach flowering season for next years crop, if you have a week or two of dry conditions, and we inevitably do, that often will give you a rally in late September early October. We love the idea of selling coffee calls above the market. Coffee presently, is trading around $1 a pound, we should get a slight rally in September and October possibly up to $1.10 or $1.15, at that time we would sell calls again in coffee with both hands, as the likelihood of a very large crop again next year will likely weigh in prices. Vietnam, of course, another big producer in coffee is looking to produce some of the largest stocks and supplies later next year, and the seasonalities for coffee to have a slight bump up in September and October is quite strong and then down for the rest of the year and down for the first quarter of 2019. That is likely going to be one of our best opportunities going into the fourth quarter of 2018, we’re really waiting on that one.

Michael:

Okay, so what we have is a strong seasonal tendency but what you’re saying is because of this record Brazilian harvest, 60 million bags this year, which that is a new all-time record for Brazil is it not?

James:

Michael it would be an all-time record. For those of you who have been following coffee and enjoying coffee for many years, we used to talk about Juan Valdez discussing and participating in Columbian coffee, the richest kind of course and for years Columbia was the largest arabica producer in the world. They would produce 11 million, 12 million bags per year and that really gives you an idea of what 60 million bags looks like and the idea that you would sell coffee calls some 50-60% above the market, where it’s currently trading, we really think that’s a high probability trade and a 60 million bag crop out of Brazil and possibly larger the next one or two years is going to make selling coffee calls very lucrative goin forward we think.

Michael:

Okay, now we’ve covered the fundamentals but I want to talk about trade strategy here a little bit in coffee because I’m sure people listening that are looking at coffee and they’re trying to figure out the strategy, yes we’ve got a great seasonal yes fundamentals look pretty bearish, but the market’s been pricing that so coffee market has been in a down trend, accelerating it looks like, the last month or so as you mentioned probably in the harvest that seasonal’s starting to kick in. So a lot of people might look and say, “Boy I really want to sell calls here after this thing’s falling so far,” and what you’re saying is you have the fundamentals support the trend you do but you’re saying it may be a good idea to wait for a rally, and that rally often comes in October because its flowering for next year, is that correct?

James:

Michael that is spot on. As we were discussing earlier stock buyers trying to thread the needle, we don’t want to do that. The coffee price hit a fresh 24 month low this week, making our coffee sales earlier this year panning out extremely well. I would be a little bit patient here for the next 4-8 weeks. We should get a rally in either September or October and at that point, I would put my tuxedo on and sell coffee calls again with both hands. Long term coffee fundamentals are extremely bearish. When you’re selling, as you know, options with the trend of the market, often people talk about option selling and the high percentages of doing that, when you’re also doing it with the trend of the market, you can probably add another 10% or 15% of the probability when selling options, and the coffee market certainly being in a down trend, let’s let it breathe a little bit over the next 4-6 weeks and then look to use a good opportunity which should be likely a pop in the market, to get repositioned for the next 6-9 months as well. I think that’s going to be one of the best trades we’ll have to wait and see if it materializes. We do need a little bump up, in September and October we usually get one on dryness concerns and at that point we’ll be putting out the green light to go ahead and do it again.

Michael:

Alright, now I know there’s the guy out there that’s going to hear this and he’s going to ask this question. He’s going to say, “Well if you think it’s going to go up in October, why don’t you sell puts?” And, I think I know the answer to that but do you want to go ahead and answer that for him before he asks it.

James:

Before he asks that question, that would be threading the needle once again. You know, we want to be long term fundamental traders, we don’t want to try and time the market necessarily. We have found that selling options a little bit further out in time and a little bit further out in price and being patient, that’s what accumulates the doubles and singles throughout the year and trying to get a quick trade in before we go bearish again, that’s just not our approach it’s not our style. A lot of investors, maybe, who sell options maybe look at two week and four week options, that’s more of the trader and less of the investor and that’s just fine, because a lot of those traders are the ones that are buying some of our options so that’s just fine with us. But, we’ll take the longer term, a more conservative approach and we want to trade with the trend, with the fundamentals, and that’s allowing a little bit of a counter fundamental rally in September and October, and we’ll go more for the long term more conservative position. For the shorter term traders we appreciate them, that’s just not our stick.

Michael:

Yeah, that makes a lot of sense and I think the key point he’d want to remember too, as you already mentioned, we’re trading with the fundamentals, always. When you’re selling options that’s the advantage we have is that fundamental data that shouldn’t let a market move too far one way or the other so you’re always trading with the fundamentals. The fundamentals are bearish, so even though you’re looking for maybe a technical bounce or a little bit of a media led bounce, the fundamentals probably aren’t going to change so you don’t want to take a trade that’s against the fundamentals, just cause you’re looking for a bump that may or may not happen. Hopefully it does give us a chance of position but if you’re looking for the highest odds you’re trading with the fundamentals that’s the basis of your whole philosophy is it not?

James:

Michael that’s the greatest point we’ve made on this podcast today, is that generally the market won’t trade or move a concerted effort against the fundamentals. We want to be long term investors we want to be patient, we are paid to wait and if you are investing on the side of the fundamentals, it’s so much easier to do that, when you’re trading technically or you’re trading based on headlines that someone read in the Wall Street Journal or watched on TV. Time is very limited, for our approach, we’re paid to wait we want to be patient and when you have the fundamentals on your side it’s so much easier in order to do that.

Michael:

Okay, for those of you who’d like to learn more and see our research piece on the coffee market and trading strategy in a little bit more detail, that will be the feature market article in our upcoming September Option Seller newsletter. That will be in your e-mail box and physical hard copy mailbox. Well it comes out in e-mail electronically on the 31st and you should get it in your hard copy mailbox a couple days after that. If you are not yet a subscriber to the Option Seller newsletter, you can subscribe at OptionSellers.com/Newsletter . We do require subscribers to have at least a $2,000,000 net worth. Well, for those of you listening I hope that has been helpful to you, we promise to ring the dinner bell for option sellers on fall seasonals, James I think you’ve done a pretty good job of that with those two markets.

James:

Michael, let’s take a look 3-4 months down the road we’ll see how we did but hopefully we teed up some really good servings of option selling going forward and always follow the fundamentals, that allows you to stay in positions that you normally might not be able to, and that’s how, at the end of the year, you’re ahead of the game.

Michael:

Okay, a little housekeeping here, for those of you considering managed option selling portfolios, going into the end or before the end of 2018, we are now booked with our new account openings into October. So, if you are considering possibly starting a portfolio before the end of the year they are filling up quickly. Rosie has a few consultation dates left in September, that is for those October openings. If you are interested feel free to give her a call, the number is (800) 346-1949. If you’re calling from outside the U.S. it’s (813) 472-5760 and of course you can e-mail her as well for information on that, that is info@optionsellers.com. James, thanks for your insights this month on cotton and coffee markets.

James:

My pleasure Michael, always great to be here.

Michael:

And for you listeners thank you for tuning in, we will talk to you again in 30 days. Have a great month of option selling.

  1. Hello,
    Thank you for the podcast, it was very informative! I just have a question about coffee, based on your podcast. Sorry if its a bit long, hope you will take your time and read it.

    In the book you said that during coffee flowering season the prices tend to go high because of fear of bad weather. Therefore looking at seasonals we often see price of coffee peaking at the end of the year, then going down in the early months of next year. Therefore strategy should be selling calls in yearly year.

    In this podcast however, you said to sell coffee calls much earlier, or wait till October – November flowering time, when there will be a rally and we can sell calls for more premium. The reasoning is that this year’s coffee crop is record high for Brazil. That of course makes perfect sense.

    However you also said in the book that coffee prices usually priced 6 months forward. So my question is, what is during October flowering the weather becomes really really bad? Will it mean bad crop for next year, and will cause prices not to just rally but shot up really high? If flowering is bad, that will cause next year’s crop to be bad and if the pricing is 6 months forward then doesn’t it mean the coffee price will shot up, despite this years record high crop (because it is THIS year’s)?

    Thus, isnt it just safer to sell calls in January, after the flowering? For example, if we sell at about flowering season, we can sell calls with strike price 1.5 because coffee just rallied to about 1.15 because of flowering bad weather fear. But then the bad weather actually happens, and coffee goes above 1.5 and we take a loss. However if we wait till January, we know flowering was bad and spot price will be about 1.5, then we sell calls and we will be able to sell for strike of 1.8 (because spot price is now much higher), which will expire worthless because of seasonal tendency to go down?

    Thank you for your time!

    • Michael Gross Says:
      September 4, 2018 at 6:23 pm

      Dear Long,

      That is quite the argument you make!

      Yes, if flowering season goes bad, next years crop will suffer, which could boost prices. The thing you must remember in commodities is that nothing is 100% certain. This is WHY we sell options in the first place.

      Our viewpoint is, flowering season usually DOES go well, it usually DOES rain in Brazil in October and November and the crop is usually fine. That is why they grow coffee in Brazil. Even in a mild to moderate drought during flowering, the 2018 crop should provide quite a cushion against 2019 crop issues.

      If there is a severe weather problem with the 2019 crop, prices could rally. But the options we suggested are so deep out of the money that there is a cushion there as well.

      If even that safeguard fails, then yes, you could lose money on the trade. That is part of trading. Again, nothing is 100%.

      Could this still be a good trade in January? It may very well be. Or, the market could have fallen further and the opportunity lost.

      At this point, we feel the odds favor sellers of the calls mentioned in the piece.

      I hope that helps.

      Regards,
      Michael

  2. Hi Michael, thank you for sharing your options ideas. I have some questions on the fundamentals of coffee if you could. For coffee, how much of the recent months decline do you think is related to the weakness in Brazilian Real and how much of the large Brazilian harvest estimate (60 mil bags) is already priced in? Thank you!

    • Michael Gross Says:
      September 4, 2018 at 9:54 am

      Tom,

      I’d estimate about 10-15% is due to the Real. For the current crop, its hard to say. Our guess is that the market has already priced 60-80% of the current crop. Again, we’re not guessing how low prices will go or when the market will potentially rebound. We are only positioning against a substantial and sustained rally – a scenario we see as unlikely in the current supply environment.

      Thanks
      Michael

  3. Larry Brown Says:
    August 24, 2018 at 5:48 pm

    I would pay money to be a “fly on the wall” in your trading room. I know you don’t do so now, but have you ever considered selling an advisory service?

    • Michael Gross Says:
      August 27, 2018 at 7:56 am

      Larry,

      Thank you. Managing portfolios for a global client base keeps us pretty busy. I doubt we would have the time (or inclination) to add an advisory service on top of that. However, never say never!

      Regards,
      Michael

  4. Ed Mlodzienski Says:
    August 24, 2018 at 3:35 pm

    do you give options to sell? how much is the service if you do?

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