Four Commodities… Four Ways to Profit
by Lee Lowell, Stock and Commodity Option Specialist
Wednesday, February 10, 2010: Issue #1194
So much for the oil rally.
The market started 2010 in blazing fashion, with March oil futures tagging $84 a barrel. Next stop: $100, right? A price not seen since the fall of 2008. Not so fast…
The market has suddenly lost its momentum and the price slumped to under $70 last Friday – its lowest level in five months.
If you want to know why, look no further than the U.S. dollar, which has warmly welcomed 2010 and rallied higher (just as my colleague Alexander Green predicted, by the way). A higher dollar generally makes commodities more expensive for other countries, thus prompting a sell-off in oil and other commodities.
As you can see from the chart below, oil futures are currently trading below the all-important 200-day moving average – a level that many market makers (as I used to be at the NYMEX) follow in order to set the price.
To see the chart in its original size, click here.
Bottom Line: If oil can’t pop back above that line within a few days, there could be more room to go on the downside – particularly if the dollar keeps rallying.
How to Profit: Depending on your outlook, there are two ways to play the oil market.
- United States Oil (NYSE: USO): This is the ETF that tracks the front-month oil futures.
- Oil Futures Options: If you want to play oil more directly, head to the futures options market on the NYMEX. Always stick with limited-risk option strategies, since oil is pretty darn volatile.
Gold Loses Its Glow
Speaking of the dollar, two commodities that had a massive party while the greenback got spanked were gold and silver.
But they’re flagging a bit now.
Take gold, for example. Having topped out at $1,230 an ounce in late December, the price has now dropped a sizeable $160 to around $1,070. Looks like that run to $2,000 that some pundits have predicted is on hold for now. It may be a long time before gold ever trades that high.
To see the chart in its original size, click here.
The Bottom Line: As you can see from the chart of April gold futures above, the technicals suggest that the $1,020 level is a solid support level.
How to Profit: If you’re looking to play the market from the long side, the main options are similar to oil…
- SPDR Gold Shares (NYSE: GLD): Like USO, the ETF tracks the front-month gold futures.
- Gold Futures Options: You can also go for futures options that trade on the COMEX. Again, stick to limited-risk option strategies.
How to Hedge Your Bets As Silver Breaks Below Support
As for silver, it’s followed gold’s lead, except for one key factor: It’s currently trading under the 200-day moving average. Having traded up to a high of $19.50 as recently as December 2009, it’s now hovering around $15.20. That’s $21,500 per single contract. Imagine holding 100 contracts?!
To see the chart in its original size, click here.
The Bottom Line: Because it’s breached that 200-day support level, silver might not hold up as well as gold in the near future. But if gold starts to move higher, silver will be sure to follow. Tread lightly with this market, as it can move fast.
How to Profit: If you’re not sure which way a market will move (in this case, silver), there are two options strategies that can take advantage of a move in both directions – a straddle or a strangle. In a sense, you’re taking a bullish and bearish position at the same time. And while it costs more money to execute both trades (since you’re buying two options at once), the reward is unlimited.
- iShares Silver Trust (NYSE: SLV): This is the ETF and trades in the same way as USO and GLD.
- Silver Futures Options: These trade on the COMEX.
Getting An Early Jump on the Beans
Finally, let’s hit the soybean market.
The bulls start to come out of the woodwork in the early spring/summer here, with traders trying to gauge planting intentions, based on the carry-over amount from the previous year’s crop. In short, they’re trying to figure out if there will be enough supply to make it through the season.
But with the threat of drought, frost, or excess rain over the growing months, most traders like to gamble on the upside movement of soybeans. This is when you can see outrageous bullish spurts occur… only to be reversed within the next few days.
With soybean futures currently trading at near-term lows, taking a small bullish position at good levels now could reward you later.
The only way to truly play this market is via futures options that trade on the floor of the CBOT. Soybean options trade in the pit and on the CME electronic platform during the day and then exclusively on the electronic platform during the night.
You can buy outright call options, or call option spreads. I suggest looking at the November 2010 options to give plenty of time for the trade to mature.
Good investing,
Lee Lowell
Editor’s Note: It’s no surprise that commodities are volatile. After all, they’re essential, everyday products that take their cue from renowned economic forces like supply and demand. Toss in any geopolitical disruptions, adverse weather conditions, and a hefty bout of speculation from hedge funds and institutions and you’ve got the recipe for a roller coaster.
And it’s this kind of volatility that baffles regular investors. Trying to judge which way an asset will move… when it will move… and how far it will move is a tough task. But when you know how to buy the stocks you want (be they commodities stocks, or otherwise) for the price you choose (a big discount to the current price) and get paid passive income for it, you’re way ahead of the game. It’s a strategy that Lee Lowell has perfected better than anyone else we know – and you can find out about it here.
- The Put-Sell Trade: How to Buy Gold and Silver for a 16% Discount
- Put Option Credit Spreads: Three Ways to Win – And an 80% Chance of Success
- Gold and Oil: Why These Two Commodities Are Set to Blast Higher in 2010
5 Responses to “Four Commodities… Four Ways to Profit”
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Along with Karim, Lee is one of America's leading options professionals. Over the course of a distinguished career, which includes six years in the options "trenches" as a market maker on the floor of the New York Mercantile Exchange (NYMEX), he has developed a proprietary trading method capable of enormous upside while actually reducing risk. 
February 10th, 2010 at 1:24 pm
Dear Sir;I like your thinking but I can’t see were you are getting your figures at?You see I have futures in july calls in USO and the price that its going for right now today is $36.19 not $74.00 that your quoting,were you getting these numbers at?I also have slv options and they are droping like dead dogs in the street you have me very confused on your prices.I would be greatful if you can put me on the right path.
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February 10th, 2010 at 1:32 pm
your prices are full of it uso is 36.00 NOT74.00
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February 10th, 2010 at 2:13 pm
Lee,
You have made a mistake with respect to GLD and SLV. These ETFs are not trying to track the front month future as they both hold the physical commodity. Although there are questions as to if their accounting and inventories are accurate
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February 15th, 2010 at 12:52 pm
Sorry your figures still don’t add up uso is still at $36.80 today 2-15-2010 not $74.00and slv etf are still dead.
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February 15th, 2010 at 12:57 pm
I agree with Mark that GLD and SLV hold the physical commodity. Both of them will have a slow slippage in price, because some of the commodity has to be sold each month to pay expenses. And because these are considered grantor trusts, if you hold them in taxable accounts, you need to report that sale each month on Schedule D.
And Stephen has a point that it can be confusing to write about the prices of oil futures and USO as though they are related. USO is a limited partnership (issues a Schedule K-1 to investors). While it tries to track the price of West Texas Intermediate Crude, the relationship between the price of USO and the price of oil depends on additional factors because of the partnership structure, including how much of its net assets are invested in oil futures at any given time.
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