How to Use Fundamentals to Target Bigger Returns and Peace of Mind with Commodities Options
August 2018 Podcast
James Cordier and Michael Gross
Michael : Hello everyone, this is Michael Gross of OptionSellers.com. We’re here with your August OptionSellers Podcast. The title of this month’s podcast is The Fundamental Advantage. We’re going to talk a little bit this month about some of the advantages you have as a commodities option seller over someone maybe sells stock options that have to worry about different things in the market that you might not have to. James, welcome to the podcast this month.
James : Michael, thank you so much. Glad to be here.
Michael : Boy, with everything going on in the news right now I think we have a timely topic for the podcast this month. One of the questions I’m getting from clients and prospective clients this month is, “What about all these tariffs? How do you see these things affecting commodities prices?” It’s a question that has a very long answer because part of that answer is in many of these commodities there may be very little affect at all, whether they’re billed up with a trade war, if it actually is a trade war, or not. If somebody asks you that question how do you typically answer it?
James : Michael, it’s interesting, I’ll be out and about, maybe out for dinner or something in a social setting, and I’ve never had so many people ask me, “What about these tariffs?” There are one or two commodities that it has affected already, nameably soybeans… that’s been in the news quite a bit just recently. For the most part for energies and precious metals and foods, like coffee, cocoa, and sugar, very little affect so far, but there are rumblings that certainly tariffs have been kind of an unknown mystery recently and a lot of people who are conducting business have a difficult time looking into the future and knowing exactly what it holds. The people that I’m most interested in watching are the people that push the buttons in Asia and Europe. Are they going to be sitting on their hands a little bit in the coming weeks and months waiting instead of conducting business? So, a bit of a drag on economies, especially in Europe and in China, and we’ll have to see how it plays out to see if this is kind of rapped up in the near term or if it drags on.
Michael : Sure. I think one thing, as a listener, you should want to take into account is a lot of people right now talking about stocks, tariffs, what’s going on in the news, or maybe it’s with China, North Korea, or Russia, and they’re looking at, “How’s it going to affect this industry? How’s it going to affect that industry? Good for this one, bad for that one.” We as commodity traders have the advantage of being able to look at those core supply-demand fundamentals because that’s really, at the end of the day, what’s going to dictate price. So, if there’s an affect we’re going to see it showing up in those numbers. Likely, I don’t want to say before they’re talking about it on TV, but it’s a gradual trend and you can see it starting to take place. You know this in some of your talking about the oil markets recently and more specifically, right now, even in soybeans.
James : Indeed. The soybean tariff basically is causing China to go to other venues, such as Brazil and Argentina. Of course, here in the United States, a lot of the producers of soybeans and corn are really getting a bit unnerved by the whole situation. Soybeans have fallen some 15-20% over the last 30 days since this discussion started. Has it bled into other commodities? Not yet, but we do see the writing on the wall and some slowdowns for some demand if this question persists.
Michael : One of the things about the tariffs in soybeans, and this kind of speaks to our lesson this month, is looking at those core fundamentals and, yes, prices are falling. How much is having to do with the tariff? It’s hard to say but they are certainly falling because the United States has an overabundance of supply this year, what it looks like. Looking at recent crop condition figures, we’re 70% rated Good-Excellent. That’s compared with 57% last year. Last year’s yield was 49.1 billion bushels. There’s talk now they could be upping this year’s yield up 50-51 bushels per acre, which would be a pretty big supply. You’d be looking at ending stocks maybe near 800 million bushel. Those are the real figures that are pushing price. Yes, there’s going to be some lower demand from China but at the same time you feel maybe some of that’s already priced into the market.
James : Michael, it certainly is. We’re really not changing the demand for soybeans, they’re just coming from different producing nations. Clearly, soybeans are created for livestock feed and demand for soybeans in the next 24 months is going to set all-time records. At the same time we have just a terrific production figure coming out of the United States later this year. So we’re kind of maybe hitting equilibrium. I think a lot of the negative points of tariffs as far as the United States soybeans go are probably priced into the market and we’re probably looking at more of a supply-demand figure domestically as opposed to globally, like we’re used to. Eventually that is going to come out in the wash and I believe that supply and demand is going to wind up dictating the price of soybeans and other grains later this year. This right now, I think, is going to turn out to be simply noise.
Michael : I agree with you, James. I think the market was priced in a tariff as soon as they started talking about it. They started pricing this back in May and a lot of people if you’re watching the news today think, “Oh, I better sell soybeans. They’re going to crash.” Well, like you said, they’ve already come down 20%. If they go any lower it’s likely going to be as a result of higher crop yields and not necessarily reacting to a tariff.
James : Yes, it certainly seems that way. Weather throughout the Midwest and Southeast for soybean growing states has just been absolutely ideal and we’re going to be looking at quite an extensive crop year in October and November when harvest begins.
Michael : So, if you’re listening to this, this is how you put those fundamentals to use. The news is talking tariff, tariff, tariff. If you know the real fundamentals, not only can you discount that sometimes, it can actually give you an advantage over the general public that, often times, is just following what they read in the newspaper.
James : Michael, we’ve been doing this for a long time and we see this all the time. There’ll be headlines in The Wall Street Journal or one of the business stations on TV and you can just see the market react to headlines. I think the last half of 2018 is going to be an incredible headline driven market and only to see 3 months-6 months later the fundamentals went out as they always do. As option sellers, and if you do know the fundamentals of the market, it can actually play right into your hands. If you’re a chartist, it really doesn’t help you much, but if you know what the supply and demand is for most of these commodities, this can be quite an advantage for sure.
Michael : James, let’s talk and move into another market here that is near and dear to your heart and that is the gold market. I know in your address to clients this week that was one of the markets you addressed. You see possibly some shifts going on there and you’re also going to be addressing TD Ameritrade’s client base next week on this particular market. Gold has been pretty depressed lately and you think that may be getting ready to change. Is that correct?
James : I do think it’s about to change. What’s so interesting is earlier this year gold was in the $1,400 range and on it’s way to the moon. We had North Korea, we had a weak dollar, we had uncertainty about interest rates, and speculative positions created all-time new high longs in the market. Of course, gold was going higher, all the headlines said it would and, lo and behold, that was the top of the market and now we’ve fallen off over $100 an ounce. Guess how the speculators are positions now? Now they’re all short the market. Technically driven investors really can provide long-term benefits for fundamental trading. When gold was pushing up towards $1,400 at OptionSellers.com we believed that inflation was not about to happen, we thought the dollar was going to stabilize and we took a short position. Basically, did exactly what we were hoping it would do. The gold market did top-out. Now, we’re sitting at extremely low levels. The dollar is now at 12 month highs and we think that’s about to change. A lot of FED watchers are looking for constant raises in the Federal Reserve loan rate. I think that over the next 4-5 meetings they’re going to probably miss out on raising at least once or twice. Each time that happens we’re going to get a bid under the gold market and we’re going to get a little bit of a softening U.S. dollar. We think that gold is a really good value here, likewise is silver, but right now all the momentum trading is down, everyone is know talking about a strong dollar, and when we see headlines that gold is going lower, when we see headlines that speculators have a record bearish position bet on the market, being contrarian is very tough to do, but when you can sell options and give yourself even more of a buffer, get in and take a position.
Michael : You bring up a good point. There was an interesting article in The Wall Street Journal recently about gold prices and what has been going on. The last two times FED raised rates on gold then the following month gold gets hammered. Now, what you’re saying is the market may be starting to forward price those and if we even miss on one or two that’s going to be a bullish impotence for gold. Is that correct?
James : That’s exactly correct. Another point that’s really curious to a lot of investors right now is, “How long will the stock market continue to go up?” We have a weakening Asian economy, we have a weakening European economy and, believe it or not, a lot of some of the smartest people on Wall Street are talking about a recession here in the United States, which would be a huge U-turn to the market. Clearly, the stock market has been doing extremely well here in the 2nd and 3rd quarter in 2018. A lot of money is going to be looking for a home when the stock market finally takes a break. Interest rates at 1.5% and 2%, will that find a home? Maybe a little bit, but I think the shiny yellow metal is going to have a few fans in the next 6-12 months and, I think, getting in around now might be a big discount to where prices might be later this year and the beginning of 2019.
Michael : Yeah, and you bring up the dollar, which was another force helping to push gold prices lower. The dollar is looking a little toppy right now. I mean, we’re talking about fundamentals and here I am talking about a chart, but obviously we do keep an eye on the technicals as well. In looking at the chart of the dollar, if that rolls over the fact that you’re talking about gold looks like it’s fairly over-sold on the downside right now. You could get a pretty decent short-covering rally at the least.
James : Well, Michael, we have record short positions by speculative bets right now. Can a bull market start that way? Yes it can. It can put in a very violent low, which we might be in the process of doing right now, I don’t have a crystal ball, but it could certainly be close. The whole idea is that the market is basically test bands in both directions and they usually out-shoot the fundamentals. When technical traders start pushing the market up it usually gets above fair-value and right now with the really big-time selling in gold and silver the last 8 weeks, I think we’re below fair value right now and I think put positions $150-$200 below the current price, especially after this sharp fall-off, is probably going to be very good sale here over the next 3-6 months.
Michael : So, you like puts below? Even if you’re wrong, you still have a $100-$200 cushion to be wrong and still come out making money?
James : Well, we really like gold around $1,000 an ounce-$1,050 an ounce. If you were to tell someone, “You know, you can still prosper from gold being above $1,050” they’d ask, “Well, how can you do that?” Well, of course, the two of us and anyone who has been listening to us knows how to take advantage of that. The gold market has fallen over $100 an ounce and I’m sure a lot of people thought it was a great buy then, now you can have a basic long position by selling puts around $1,025-$1,050… over $200 below the current price. I think that’s going to be a good position going forward to sell that premium.
Michael : Listening at home, tying this back into the theme of this month’s podcast, all you hear on the news right now is bearish gold, bearish gold, gold has been falling since April, and what James is talking about, Commitments of Traders report here, that’s something that anybody has access to. It shows you how many traders/speculators are long, it shows you what the commercials are doing. You can take a look at that, see who’s getting long and who’s getting short, and at what rate. I know, James, especially when you’re dealing with markets like gold where you may not have the crop figures and things like that like you do in the agricultures, that can be a key fundamental to watch and I know it’s something you watch pretty closely.
James : It certainly is. The headlines move the markets for a short period of time. They inject volatility into premiums on both puts and calls. As fundamental investors, as we are and always will be, that’s where the market dictates levels to be in the future. Having tariff ideas and a lot of the discussion about what the economy is going to do can really play into the hands of people who know the fundamentals. Technical buying and technical selling is great for day traders but, if you want to be truly investing 3, 6, 12 months out, the fundamentals are the big advantage on your side when you can put them into play.
Michael : If you’d like to read more about using fundamentals to gain an advantage when selling commodities options, we do recommend getting the latest copy of our book, The Complete Guide to Option Selling. That is currently in its Third Edition through McGraw-Hill. You can get it at your local bookstore, you can get it at Amazon, or you can also get it at our website at a discount to both of those places. If you’d like to get a copy it’s www.OptionSellers.com/Book. James, let’s move into our final market this month and this is one that really has some fundamentals you can sink your teeth into and some that the general public probably doesn’t know how or where to look for them. We’re going to talk about some of the advantages you can get here. That is in the gasoline/crude oil market. It’s obviously a very seasonal time of year for them. We’re right in the midst of driving season right now; however, something starts to, or at least has historically started to, happen around this time of year that traders can put to work for them. James, do you want to point that out or what you’re looking at right now?
James : Michael, historically, gasoline prices reach low levels in December, January, and February for obvious reasons. Basically, people are kind of land-locked in the Northeastern United States where we have just massive population being condensed in just those several states and then come June, July, and August they’re all out and traveling. That really does make a difference. You might want to ask, “Well, what’s a couple gallons of gas here or there”, but when you’re talking about 100 million people driving in the Northeast it’s a very big deal. Basically, gasoline prices normally starting rallying in the months of March, April, and May as we start getting ready for driving season. They reach, normally, peak levels in July and August and then they start to taper off. While this year may or may not turn out to be that way, it is certainly setting up that way. Gasoline demand this past week hit a new record. We’re expecting prices to be relatively lofty here for the next 4-6 weeks and then we’re seriously thinking that as demand starts falling off in September/October, so will the price of gasoline and then, of course, crude oil. Then we’re looking at taking advantage of that in the next 30 days or so.
Michael : James, I know you’re talking here, explaining the seasonal just a minute ago, past performance is not indicative of future results as we all know; however, when you look at this chart and put the price chart over the seasonal, it’s matching up nearly perfectly this year.
James : This year’s seasonal price move in the energies is almost tick for tick with what it normally does, and the seasonalities are just that. They’re basic references for you to follow. From time to time a market, the 8 markets that we follow, might not be in step with seasonal factors. This year is different. In gasoline and crude oil it is following extremely closely and that leads us to believe that this fall and winter it will continue. As far as the high price right now for gasoline and oil, the writing is on the wall for this year to maybe repeat itself and have a soft oil price in October, November, and December.
Michael : When you talk about using the fundamentals to your advantage, all the news right now is OPEC, what’s OPEC doing, the crude oil market, the unleaded gas market, yes that can have an impact but those news stories tend to take on a life of their own, and basic commodities tend to take their price direction from their core supply-demand fundamentals. Again, if that’s having an affect it will show up in price, it did last year when OPEC took supply off the market, but now we’re heading into that period of slack or demand. The seasonal, often times, you’ll see a secondary top in late August/early September and then we just fall in price into that coinciding perfectly with that slack demand season. So, it’s no guarantee it’s going to happen again this year, but Economics 101 would tend to dictate that when demand starts to fall price tends to fall with it. It has tended to happen that way in the past and because we see it happening this year on the chart we expect it to happen again.
James : Well, hindsight is 20/20 and it’s the looking out in the future that’s the difficult part. Once again, that’s why we sell options because we don’t know where the exact highs or lows are, we don’t know when a market is going to trade seasonally or on different fundamentals, and that’s why you like to have the big buffer of selling options far out-of-the-money so that if a particular seasonal factor doesn’t take place then you have a large window for the market to still call you right. We’re going to be taking a look at that here in August and we’ll see what the market holds.
Michael : Now, obviously seasonals, we consider seasonals a fundamentals and I think they’re a key fundamental, but there’s a couple other reasons gasoline and possibly crude oil start to move lower here. One is, as you pointed out in the upcoming August newsletter, gasoline stocks right now are, looking at the figure here, but they’re 10% above the 15-year average for this time of year. They’re near an all-time high for this time of year and that’s because refineries have been operated at a near record rate. So, they’re cranking out more gasoline, pushing supplies to near an all-time high. That is probably going to cause them to, at some point, start to slow down the refinery rate here because they’re going to have plenty of gasoline. That higher supply could also probably exacerbate the seasonal and give some seasonal price pressure into fall as well, I would think.
James : Michael, I think you pointed out correctly… seasonality does coincide with fundamentals. As gasoline demand finally does taper off in August and September, what happens is the crude oil that has been used to crack into, especially gasoline, for summer driving season starts to build up. I believe that we topped over 11 million barrels of production this past week in the United States, an all-time record high. As soon as that cracking into gasoline starts to slow just a little bit, we’re going to see barrels of oil come on to the market looking for a home and, usually, that tips the market over and that’s what they, usually, directs the seasonal to go south starting in September and October. We don’t know that it’s going to happen again that way in the 3rd and 4th quarter but it’s certainly setting up to be that way so far.
Michael : Now James, you’ve talked recently, I know we’ve been taking premium from both sides of the energy markets for some time now. It has been a pretty solid producer. As far as this particular play for the investors sitting and home and saying, “Hey, I may try a few of these and see how it goes”, what’s the type of position he could look for? Would it be gasoline, would it be crude oil, or what’s he looking at?
James : Michael, we all, as you know, want to err on the side of caution as far as being in the most liquid markets. The gasoline market used to have a terrific amount of option buying and selling volume and it has dried up slightly over the last few years, whereas in the crude oil market, the liquidity there is absolutely phenomenal. A person can buy or sell thousands of options by the minute in that market. It’s absolutely gigantic volume trading market. What we suggest right now is being in the, when delving into the energies, we do think about selling options in crude oil as opposed to gasoline; however, taking the same analogy and taking the same fundamental view and just use that apply it to crude oil options. Right now, the crude oil market for the December contract, that is going to be the most liquid contract coming up. That market is trading around $66 a barrel recently. The next coming year in June is trading around $63-$64 a barrel. We actually think that is really a sweet spot for the market. Getting much higher than that we’re going to get a lot of pushback as far as we need more production in the United States and elsewhere, and if the market falls of $10, maybe down to the high 50’s, you’re going to see OPEC start tightening up with the reigns again. I think, right now, an excellent opportunity in oil is to sell puts and calls at the exact same time. We’ve been applying a strangle strategy over the last few weeks where we’re selling options $50 and $55 apart, giving a $65 market, such as crude oil, a $55 window for it to trade inside. We think that’s absolutely one of the best opportunities on the board right now and that’s something that we’re taking advantage of right now. If, in fact, the oil market rolls over slightly this fall along with the gasoline, something we expect will happen, and that would comfortably stay inside of our parameters of selling our strangle, so that’s what I would be doing for any home investors out there that are listening in and selling a $55 strangle in oil. I think that’s one of the best opportunities on the board.
Michael : So, although you see prices maybe coming off a bit into fall, you see them more as trading in a wide range, maybe they’re just near the higher end of that range, and may come off into the fall, that doesn’t mean they’re going to fall out of bed and they’re still could be if you’re an option seller. Again, you don’t have to pick how far it’s going to fall or where it’s going to go, you’re just picking those points outside the ranges where it will be. You think you can double up on the premium here and get it from both sides?
James : You absolutely can. The fundamentals in oil have changed over the last 2 years. We used to have just an incredible glut of oil floating on the seas and in storage around the world. With OPEC’s cut in production over the last 18 months, a lot of that surplus has disappeared. So, while we do see prices easing to fall in winter, we don’t see them falling more than probably $8-$10 a barrel. If we have a $50 window for the market to stay inside, I think that would do quite well. Anyone who is wanting to try and time the market, we don’t do that. We just look at the long-term fundamentals. I would be looking at selling calls in the $90 range now and later this fall and winter selling puts maybe $35 or $40. We like the idea of long-term fundamentals saying the market’s going to stay inside that window. We’re not going to try and time the market, however the fundamentals and the seasonals over the next 30-60 days say we could have a slide in the market starting in September and October. So, I guess investing is personal. That is the approach that we’re taking and, of course, everyone gets to vote, it’s their account, and do what’s best for them.
Michael : James, that brings up a good point because a lot of times when I’m talking to prospective clients they’ll say, “Well, I’ve always wanted to do commodities but I don’t know anything about it. I don’t understand the fundamentals. It’s too much to watch.” Actually, there’s less to watch than in stocks. You have to watch so many different things and there’s so many different moving pieces in stocks. In commodities, there’s a couple core supply-demand fundamentals. If you know how to track them, you know what the seasonal is, there’s really not as much to watch as a stock. You just have to find the market and know what to look for and where to get it. Certainly one place you can start is with our newsletter,The Option Seller Newsletter. The August edition of The Option Seller Newsletter will be coming out the 1st of the month. If you’re already a subscriber it will be in your e-mail box and your hard copy mailbox probably a couple days after the 1st. If you would like to sample a free edition it is for high net-worth investors only. You must have a net-worth over $2 million. If you do have that, you can get a free sample subscription at www.OptionSellers.com/Newsletter . James, let’s move into our lesson because it does talk a little bit about some of these things we’ve been referring to, that is how an investor that’s maybe just getting into commodities or wants to start diversifying in the commodities give their portfolio an extra asset class outside of stocks and real estate or some of the more common investments. Where would somebody start? Say for fundamental data they want to find the data on crude oil, like the things you’re talking about right now. Where would you start?
James : Michael, the Commodity Research Bureau puts out just an incredible publication anywhere from asphalt to zinc and every commodity in between those. That’s where I would start. There are pages and pages and pages on the coffee industry, there are pages and pages on the cocoa industry and crude oil and right on down the line. That gives you the basic knowledge you need to be a fundamental investor. Years after learning those fundamentals you will then, hopefully, get good at understanding what is priced into the market and what has yet to be priced into the market. That is the secret sauce. Reading The Wall Street Journal every day, they’ll talk about the price of oil was up $0.50 yesterday because the supply was down 2.2 million barrels. That’s all fine and good but what are the long-term fundamental drivers in the market? What is the market looking like 3 months, 6 months, 9 months out? You can get a feel for that and you can understand how to apply those fundamentals by getting a nice foundation of knowledge. The Commodity Research Bureau allows you to just know everything about where coffee is grown, who is the largest consumer, who is the largest producer, did Russia overtake Saudi Arabia recently as the largest pumper of oil in the world, the United States just took over 11 million barrels… the amount of knowledge that someone can gain in just probably a year or two or analyzing the market could allow you to be a great investor for years and years. I know I was studying silver when I was 15 years old. I remember charting the market and putting the charts on the wall in my bedroom. I’ve been following commodities for over 30 years and I think it helps just immensely. I can tell you what the market’s going to do a week from now, but I can often tell you what the market’s not going to do a year from now. Having that fundamental knowledge, I think, is a big advantage for ourselves and for our investors. Anyone wanting to gain that knowledge you do have to put your time in. What’s so interesting about investing in general is when you have a good feel of the fair value for a market and when the market’s going against you slightly you’re able to hang onto your core position. If you’re investing in something that you don’t know, if you’re investing in something where you’ve got a hot tip, your staying power is not very good and if you are staying beyond your regular point of risk control, you’re probably staying and you’re probably staying in for the wrong reason because you really don’t know. Having the fundamental knowledge is paramount to, not just being a trader, not just being a speculator, but being someone who is investing. We’re certainly big proponents of investing and not so much as to dabbling in the market, Michael, as you know.
Michael : Yeah, well absolutely. You bring up as far as places to look for a type of fundamental, obviously Commodity Research Bureau is one of the best places. One thing I tend to recommend is also the USDA for a lot of the agricultural markets. While this may sound foreign to some of our younger listeners, pick up a book. There’s a lot of good books out there on fundamental data. I know when we were young and there was no Internet and you wanted to learn about something you went and got a book on it. I still think that’s one of the best ways to learn about things. Obviously our book, The Complete Guide to Option Selling, we cover a lot of the basics of fundamentals, but there’s some other good ones out there, as well. Schwager on fundamentals, one of the classic books on commodity fundamentals. I’d recommend that if you really want to get in and understand that. Obviously using a lot of the resources we make available, James, a podcast just like this, our videos, our newsletter, we focus a lot on the fundamentals and try and boil them down a lot for, not just clients, but just people who want to listen and learn a little bit more about it.
James : Several times I’ll be talking to new clients on their new account call and, while they don’t want to be doing the investing, they don’t want to be selling the options, but they hand that over to us as their managers, practically everyone I talk to thanks us for the fundamentals that we bring to the average investor. The people who become clients of ours and other people that don’t have thanked me several times because a knowledgeable investor is a good investor. Someone who has done the research, whether it’s their brokerage or whether it’s themselves, that just puts a very large advantage. Are you right all the time with all of your investment because you’ve got a fundamental background? Certainly not, but investing should be done as a long-term idea, not just as “Well, I got this one right, I got this one wrong”. Every December 31st how did you do? If you have a fundamental background in the market chances are you’re going to beat a lot of other investors. You can also beat even a rallying stock market. That’s what we try and do for our clients.
Michael : If you’re listening and you’d like to know some of those key fundamentals, again, I recommend reading the fundamentals chapters in our book, The Complete Guide to Option Selling. Also, on our website, if you go to the video lessons page there are videos there from both myself and James where we do talk about specific fundamentals, fundamentals of agricultural markets, there’s one where we talk about the figures, and James has some there talking about the energy markets, so there’s also a good resource for you if you’re interested in learning how to do this. James, I think we’ve covered a lot of ground this month and a lot of people hopefully learned how they can maybe use fundamentals to really gain an advantage in selling commodities options. James, I do appreciate your input and good luck on your interview with TD Ameritrade next week.
James : Looking forward to it Michael and looking forward to speaking to our listeners again 30 days from now.
Michael : I am, as well. If you’re wondering about account availability this month, we are now booked through September so we are starting to book October account openings now. If you’re interested in booking a consultation interview for those upcoming openings there are still a few left in August. If you’d like to contact Rosemary at the office, the number is 800-346-1949 to schedule one of those remaining consultations. If you’re calling from outside the United States, the number is 813-472-5760. You can also e-mail your inquiry to office@OptionSellers.com. Everyone, we appreciate your listening this month and we will be back again in 30 days. Have a great month of option selling. Thank you.