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Larry,
Yes, good question. I'll use corn as an example although there are many
commodities to which the techniques apply.
Corn has been consolidating around 30 year historical low range $2.00 -
roughly cost of production +- 25 cents. Historical high range (typical
cyclical high not the extreme) is $3.50 - a range off $1.50 * 5000 Bu
per contract or $7500. Commodities run in a basic cycle which varies,
but for corn is typically 3-5 years top to bottom and 2-3 years bottom
to top. When a commodity falls to COP, producers cut back, inventories
fall, supplies get tight, prices rise, and producers increase
production. Whether planting fields, reopening mines, or drilling wells,
there is at first disbelief and reluctance to invest fresh money when
prices begin rising, followed by time to actually increase production
and get it to market. Each futures contract has a life of 12-24 months,
contracts are spaced with expirations 1-3 months apart depending on
commodity, and the contract closest to expiration becomes the "front
month". Next delivery contracts (those beyond the current month)
generally sell at a premium reflecting costs of carrying inventory until
delivery. Since one wants to hold reasonably liquid contracts, one buys
the current front month (or possibly the closest next month) and rolls
into the next contract prior to expiration, generally at a premium plus
commission.
Depending on the contract selection and the time it takes for prices to
rally from low to high, one might end up rolling between 6-10 and 10-15
contracts from low to high at a spread of 2-4% + $15-30 in commissions
and fees. My basic strategy is relatively simple. Buy front month
contracts near support when I believe they are well supported and ready
to rally, replace wide cash stops with out of money (next month) puts
when prices rise (buy puts when no one wants them), and sell front month
out of money calls when I believe a rally is about to hit a wall (sell
calls when everyone wants calls). Also, if enthusiasm becomes excessive
I could very well lighten up a bit to book some profits.
Thus I bought March corn close to 200, bought May 200-210 puts as March
corn rose though 215-220 and am offering March 230-240 calls as March
price rallies sharply. The puts are not purchased to lock in profit, but
to provide cheap disaster protection and free up cash reserves for the
purchase of more contracts on the following retracement. I pay a slight
premium for next month puts but the decay is slower and coverage longer.
The calls (on some, not all contracts) are sold to bring in cash flow to
pay for the puts and rollover costs and are targeted to expire out of
the money during a retracement or be repurchased at a discount during a
retracement. Should the market get so exuberant that the calls I've sold
go into the money and my contracts are called away, I'll pocket my
profits and wait for a retracement (or move on to another commodity).
Thus the whole process is run like a long term business complete with
staged investment and pyramiding of positions along with cash flow from
operations. Contract margin (cash deposit required by the exchange) for
corn is around $500 (I don't know the precise amount) for the $10,000
(approximately) worth of corn so the opportunity for leverage is large,
however I don't use a lot of leverage. Since this is a long term
proposition, I allow enough to sustain prices below COP plus a cushion -
roughly $2500 per contract until I have it hedged with a put. The put
also protects against something which cash stops do not - a large
adverse move across a series of limit down days where the position can
not be liquidated at any price much less the stop price. Obviously, the
business requires some sense of timing rallies and retracements,
although perfection is not necessary.
Earl
----- Original Message -----
From: <Scaletrade@xxxxxxx>
To: <eadamy@xxxxxxxxxx>; <realtraders@xxxxxxxxxxxxxxx>
Sent: Thursday, January 13, 2000 3:09 PM
Subject: Re: [RT] Possible bull flag in corn
> Earl,
>
> I believe you were the one who posted 2-3 days ago that you expected
several
> thousand dollars in gains in the grain complexes, per contract, over
the next
> 2-3 years. As one who finds it hard not to take a profit when it
presents
> itself, I'd be curious to know how you plan to play it. Are you
making a
> position move and just going long the dec 2001 corn market, for
example, to
> wait it out? Or do you plan to jump in and out of the market many
times over
> the next several months to years, based on technical considerations?
>
> I'd appreciate any comments. Thanks,
>
> Larry
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