Tag Archives: peter-knight

Should We Be Getting Ready To Cover Our Shorts In Energy?

Summary Crude oil priced in gold is near a 30-year low. Crude oil priced in inflation-adjusted dollars tells another story. What are the crude/gas ratios and technicals telling us about our short positions? Getting paid to be patient while we wait for the bottom in energy markets and stocks. Now that oil and gasoline cost less than bottled water, maybe it’s time to start looking at covering our short positions. Don’t get me wrong; I’m not ready to use the L word just yet (long), but I can clearly see long positions on the horizon at lower levels. The downward spiral is still intact, but history has proved short-selling parties can’t last forever. Just how inexpensive is crude oil? Let’s look at the 30-year chart for a barrel of crude priced in gold. All-time high 0.15050 of an ounce, June 2008. All-time low 0.03322 of an ounce, July 1986. Current 0.03370 of an ounce, December 2015. 1986-2015 average, 0.69889. Distance from the all-time low priced in gold 0.00048 of an ounce or about 50 cents. Source & supporting data Federal Reserve data 1986-2105-cost-of-oil-priced-in-gold 1986-2015 oil gold ratio (oil normally trades above gold on this ratio) Source Federal Reserve Is $34.52 per barrel misleading if you look at the historical price action from 1993-2015 calculated in inflation-adjusted dollars? All-time high $147.27 per barrel, July 2008 ($162.34 in 2015 USD). All-time low $10.35 per barrel, December 1998 ($15.80 in 2015 USD). The 30-year average price for oil is $42.87 ($59.09 in 2015 USD). 2015 dollars generated using the bls.gov inflation calculator . Current cash oil price $34.52 per barrel Data source Chicago Mercantile Exchange The fundamentals are still weak The technicals are still weak Daily = downtrend Weekly = downtrend Monthly = downtrend The spread between a gallon WTI crude and wholesale gasoline is more than twice the historical average. 1990-2015 historical average, $0.2147 ($0.28 in 2015 dollars). Current 12-month rolling average = $0.4426. Spread between WTI crude and retail gasoline, better than average. 1990-2015 historical average is $0.8642 ($1.14 in 2015 USD). Current 12-month rolling average = $1.2612. Spread between wholesale and retail gasoline, consistent with the historical average. 1990-2015 historical average is $0.6496 ($0.86 in 2015 USD). Current 12-month rolling average = $0.8186. Where the futures market is pricing crude oil through December 2024. Ratios tell me to maintain shorts, technicals say stay short, futures markets indicate higher prices. One current crude oil position to track Short March 2016 deliver at $46.80, contract value $46,800. Deposit posted per contract = $15,000. Exchange margin per contract = $3,800. March 2016 is currently trading at $36.74, contract value $36,740. I’d like to cover these $46.80 shorts, reverse to long at $33.00. 1) To cover my $46.80 shorts, I’m going to write a put at the $33.00 strike , collecting $1.24 per barrel or $1,240 per contract (expires in 58 days). The only way my current $46.80 short can be “pulled” away is if the market falls from the current price of $36.74 down to $33.00. Should this occur, my short position would appreciate by another $3,740 per contract between now and 17 February 2016 expiration. If March delivery never goes down to $33.00, I keep the $1,240 put premium collected against my $46.80 short. 2) I’m also going to write another put at $33.00, collecting another $1,240. Again, if March 2016 WTI crude does not trade down to $33.00, I keep the $1,240 in time premium. If it does go below $33.00, I was paid $1,240 to enter a new long position at $33.00 or $3,740 per contract better than where the market is currently trading ($36.74), (yes, I’ll have to offset and roll the position in March). 3) If the market stays the same, I’ve collected $2,480 over the next 58 days on a position if delivered is worth $33,000. 4) If oil starts to rally, I can cover my $46.80 shorts and watch the $33.00 puts expire worthless (+$2,480). There are several other ways to offset my $46.80 shorts, example, writing an in-the-money put at $40.00 currently trading at $4.59, collecting $4,590 in premium ($920 in time value). On the upside, the current position is trading at $36.74 contract value $36,740 (1,000 barrel contract x $36.74 per barrel) or I’m getting paid 6.750% in total time value over the next 58 days to liquidate my $46.80 if the market goes down to $33.00. If $33.00 in put is hit, my gain on the trade = $13,800 per contract plus the collected time value of $2,480 for a total of $16,200. The margin I’m allocating on this position is $15,000 per contract ( exchange margin = $3,800 per contract). What this strategy has done is paid me 16.53% in option time value on my $15,000 deposit per contract to be patient over the next 58 days. Many traders don’t realize how collecting fat time premium can work for you. Let’s assume the market is right and crude oil bottoms at the current price of $36.74 (March 2016 delivery). Let’s assume you go long crude oil at $36.74, wrote an out-of-the-money call at $39.50, and the $39.50 call is trading at $1.59, then you’re collecting $1.59 per barrel, $1,590 per contract, $27.41 per day or $10,006 per year on a position that has a total value of $36,740. The time value writing out-of-the-money options = 27.23% in annual time premium collected or 66.70% on the $15,000 allocated to cover the $3,800 in exchange margin. We’re posting $11,200 more than is required by the exchange to minimize the probability of a call. Our margin for error without being in jeopardy of having a call is $11.20 a barrel plus whatever option premium collected; in this case, $1.59 for a total of $12.79. In order for us to be on call (in this example) March 2016, crude oil would need to fall below $23.95 a barrel between now and 17 February 2016 (58 days). Again, I’m not advocating getting in at $36.74, I’m using this as an example to show you how hefty the time premium is writing out-of-the-money calls to generate income against a long crude oil position. In this example, the only way your $36.80 position can be called away from us is at $39.50 for a $2.70 profit per barrel or $2,700 per contract. If it does not get called away, we’d keep the time premium against our long of $1,590 (+10.60% on the $15,000 deposit for 58 days). In my case, I’m writing the $33.00 put to get into a $33.00 long position collecting $1,240 in time value; if delivered at $33.00, I’ll write the $36.00 or $37.00 call against the delivered $33.00 long collecting another $1,000 to $2,500 against the $33.00 long (I will have to roll this position to forward delivery month). Energy Stocks Energy stocks might not be as sick as all the academic chatter generated by the tradeless master debaters. Sure, crude may go down to $20, maybe $10, who cares? There are defined risk strategies to capture the move in both crude and energy stocks if you’re up to speed and can handle the risk. Fact, over the next five years, the world will need energy and the additional products crude produces. Demand may go down, but population will increase, and there are scores of situations that could generate a nice rally in crude from the low $30s as well as energy stocks. Many of these energy stocks you can trade using the same strategy of writing puts to get in and calls to get out as I’ve explained in the crude oil example above. Word of caution, you have to watch your bid/ask spreads, make sure you get firm quotes on the bid/ask, match them up to your other desks and always use price orders. On the horizon, I see short covering and potential net new long positions entering in energy stocks. Yes, the charts still look ugly. If you want to be less aggressive, wait for the turn (change in trend) using something as simple as a Bollinger 20,2 and exponential moving average 9 on weekly data in the examples below. Exxon Mobil Corporation (NYSE: XOM ) BP p.l.c. (NYSE: BP ) Royal Dutch Shell plc (NYSE: RDS.A ) Chevron Corporation (NYSE: CVX ) Valero Energy Corporation (NYSE: VLO ) (no short on this) Petrobras – Petroleo Brasileiro S.A. (NYSE: PBR ) Marathon Petroleum Corp. (NYSE: MPC ) (no short on this) ConocoPhillips (NYSE: COP ) Suncor Energy, Inc. (NYSE: SU ) Total S.A. (NYSE: TOT ) Statoil ASA (NYSE: STO ) Yes, oil is inexpensive and appears to be moving lower, but the world still needs it. We will eventually find a bottom, might as well get paid on our short positions while we wait.

Portfolio Diversification Strategy During The Fed’s Rate Hike Cycle

Summary Where the Fed, analysts and the market see the Fed funds rate and when. What we’re trading and how to capture the move higher in the Fed Funds rate. How to experiment with any potential outcome for this fully disclosed Fed Funds Trade. HCB Stocks & trading strategy, which I believe will offer a superior return on risk during the rate hike cycle. I believe diversification and objective risk control will be essential during the next 36 months as the Fed gradually hikes rates. My objective of this report series is to introduce new sectors and strategies to capture the major market moves being generated by current extreme economic fundamentals. As opportunities develop in metals, energies and currencies I’ll share what I’m doing in these sectors and how. I encourage your comments on sectors and trades your in with similar or higher returns on risks. The goal of this report series is generating POSITIVE dialogue among fellow TRADERS who share the objective of finding the most effective solutions to the problem of making money. It’s not set up for tradeless academic master debaters who can subjectively criticize but can’t offer objective facts to support their opinion or a solution. In this report I have provided strategy to capture the move higher in the Fed Funds rate over the next 13 months . I’ve also included 11 HCB stocks (high cash buffers) that could benefit from higher rates and included defined risk strategy on how to trade them during the rate hike cycle. The first rate hike in 10 years is on deck in 5 days (16 December 2015). Using this fully disclosed strategy even if the Fed is wrong about the Fed Funds rate the Fed sets, there is no hike on 16 December 2015, this position is structured to maintain and capture any future rate hikes over the next 9 FOMC meetings through 31 December 2016. Last objective guidance where Fed Chair Yellen sees the Fed Funds rate and when (video 1:59) Source Federal Reserve What the move is worth Current contract value = $552 (cash market 0.1325%). Fed projection by December 2016 = $7,500 (1.8000%). Fed projection by December 2017 = $13,125 (3.1500%). Probability = 85.30% for 16 December 2015 . Source Chicago Mercantile Exchange Click here for more information on what this rate is and how it’s set. One simple trade to capture the move higher in the Fed Funds rate through 31 December 2015 . Trading the Fed Funds rate higher requires establishing a short position in the underlying futures contract . To convert the contract price into the rate it represents Take 100.00 – the contract price = the rate. Example 100.00 – a contract price of 99.46 = a rate of 0.54%. Each 0.01 change in price = $41.67 change in contract value. Position Short at 99.46, the December 2016 CME futures contract (ZQZ16) Trading this rate higher from 0.54% Contract value = $2,250 Objective The Fed’s target by 31 December 2016 Contract price = 98.20 Rate = 1.80% Contract value = $7,500 Click here to enlarge the rate, price, valuation chart below Current chart and quotes To experiment with any potential outcome for this trade. Click here and open the interactive risk reward spreadsheet Watch the 5 minute video linked below on how to use it As this position appreciates we’ll update its performance and share hedging strategy/updated spreadsheest showing you how we’re locking in gains. This trade was originally posted on Seeking Alpha 12 October 2015 . Federal Open Market Committe meetings schedule & Fed statements The last tightening cycle from 1.00% June 2004 to 5.25% June 2006 Stock diversification strategy during the rate hike cycle Below are 11 companies that have built sizable cash buffers and links to monitor them on SA moving forward: Apple (NASDAQ: AAPL ), Microsoft (NASDAQ: MSFT ), Alphabet (NASDAQ: GOOG ) (NASDAQ: GOOGL ), Pfizer (NYSE: PFE ), Cisco (NASDAQ: CSCO ), Goldman Sachs (NYSE: GS ), Moody’s (NYSE: MCO ), Oracle (NYSE: ORCL ), AT&T (NYSE: T ), AbbVie (NYSE: ABBV ) and JPMorgan Chase (NYSE: JPM ). From past ratios and what I’m seeing between interest rate hike expectations through December 2018, relative to stock price change, it appears rate hikes might actually fuel these stocks higher. I’m trading these stocks using “collars” to define my risk on all trades and for the duration of every trading period. Example of a “collar” to define risk: Own 1,000 shares of GOOGL at $745 Write the $800 call collecting premium (1,000 shares) Using the collected premium buy the $700 put (1,000 shares) Trade outcomes 1) The market stays the same, if you set the trade up right you should be collecting approximately as much time value on the $800 call you’ve written against your $745 long position as you’ve spent on the purchase of the $700 put to hedge the position. In some scenarios you’ll actually have a credit. 2) Market sells off hard to $500, your loses below $700 are negated by the put you’ve purchased at $700. At $500 you can offset the put for a $200 profit and reestablish a new hedge by buying a new put at $500 lowering your entry cost by $200. Your new average entry price has now dropped from $745 to $545 making recovery more obtainable. 3) The market continues to move higher and the position is called away at a profit at $800, you can always reestablish it. Click here for more on Seeking Alpha on why we’re trading these high cash buffer (HCB’s) stocks and how.