Commodities May Gain 10% a Year, Credit Agricole Says

Commodities May Gain 10% a Year, Credit Agricole Says
By Claudia Carpenter
April 13 (Bloomberg) -- Commodities may gain 10 percent a year this decade, outperforming the Standard & Poor’s 500 Index of stocks, according to Credit Agricole SA.
Raw materials will generate stronger returns than the annual 3.4 percent from 2000 to 2009, Jean-Francois Perrin, asset allocation analyst at Credit Agricole Corporate & Investment Bank, told reporters in London today. At the same time, though, the risk of losses will increase, he said.
The Dow Jones-UBS Commodity Index Total Return gained 19 percent last year as oil, sugar and copper climbed. The gauge slid 36 percent in the prior year as the world financial crisis cut into demand for raw materials. /
“Commodities could be more risky because they’re starting now at a point that’s not so undervalued as in 2000,” Perrin said. “While commodities are fairly priced, we think there are so many constraints on supply in the long run they will likely increase.”
Raw materials as represented by the Dow Jones-UBS gauge will be as risky as the S&P 500 through 2020 and riskier than nine other benchmarks including the MSCI BRIC Index of shares, Credit Agricole estimates. The MSCI index of shares in Brazil, Russia, India and China will rise 11 percent a year through 2020, compared with gains of 6.5 percent a year for the S&P 500, the bank said.

HOW TO TRADE COMMODITIES

The commodities market is essentially a wholesale market. It is comprised of many common, household items but the difference is that trading these commodities is done in large bulk. For example, when you go to the grocery store to buy sugar, it is usually in five-pound bags. In the commodities market, you can buy sugar too, except that it is for 112,000 pounds! Here's another example. When you gas up your car or truck, you pay for gasoline by the gallon and maybe purchase 10 or 20 gallons. In the commodities market, you can also buy unleaded gasoline but the standard transaction size is much larger; 42,000 gallons! That's a lot of gasoline!
Because of the large size of these "wholesale" transactions, very few people ever trade commodities with the intention of actually using or consuming the item if they bought, or delivering the item if they sold. There's just too much of it! The great majority of commodity traders buy and sell only to profit from price movements. They are called speculators. And they are drawn to the commodities market in search of high-yield investing opportunities.
So what are some of these commodities? Well, the oldest and perhaps best known are the grains like corn and soybeans. Then there are the meats such as live cattle and yes, pork bellies. There are contracts on the energies such as crude oil and unleaded gasoline, and on precious metals such as gold and silver. The softs include cocoa, coffee, sugar, cotton and orange juice. Finally, there are financial products such as bond futures, equity index futures and currency futures. Any one of these markets can provide an opportunity when commodity trading.
In addition to the wide selection, there is another great advantage to commodity trading: You can sell before you buy. Most investors are comfortable with the typical investment pattern of buying first and selling later. While useful during a bull market, you typically just have to sit on the sidelines if prices are falling. In the commodities market, though, you can sell first and later buy back. Selling first is possible with commodities because when you sell a commodity contract, you're not required to deliver anything. Delivery is required only when the contract reaches expiration which may be weeks or months down the road. As long as you buy back the contract before its expiration, then you will cancel this obligation to deliver. And if prices have fallen in the interim so that you buy back at a lower price, then you have made money!
Perhaps the greatest appeal of commodity trading is high leverage. This means that to buy or sell a commodity having a contract value of say, $100,000, the commodity trader need only hold a small portion of this value in a commodity trading account, maybe $3,000 or so depending upon the contract. Because of leverage, the trader gets a big back for every buck. In the example above, a one percent change in the market value of the commodity contract would be equal to $1,000 or 33% of the margin. Leverage is what makes commodity trading risky and is described in greater detail in Understanding Commodities at right.

Let’s take a look at how the strategy works with this position. For the sake of our illustration and to make our calculations easy let's establish the collar using the December 27.5 put and the December 30 call, with both trading at $1.00. Remember our future options price was $28.50. The cost of the collar will be $0 because you paid $1.00 for the put but you collected $1.00 from the sale of the call. How does the collar work in our usual three scenarios: the “up” scenario, the “down” scenario and the “stagnant” scenario? In the “up” scenario, we find that when the future options rise, the investor gains penny for penny until the future options reach the call strike. Once the future options reaches that level, the position no longer gains because the future options are at the point where they will be called away.Capital gains of the position are maximized when the future options reach the call’s strike price. Let’s take a closer look at what happens as the future options price goes up. With the future options at $29.00, both the Dec. 30 calls and the Dec. 27.5 puts are out of the money and thus worthless. Since there was no debit or credit incurred in the future options, the option profit (loss) is $0. Only the stock position remains. The future options purchased at $28.50 are now trading at $29.00 for a $.50 profit.Let's raise the future options price to $30.00. The puts and calls are again worthless so your profit (loss) is solely determined by the future options. The future options, which was purchased for $28.50 is now worth $30.00 and represents a gain of $1.50. This $1.50 gain is the maximum gain the position allows.Once the future options go over $30.00, the Dec. 30 call, which we are short, would become in-the-money and therefore the future options position would be called away at that price. When the future options price rises to $31.00, the puts would be out-of-the-money thus worthless but the calls would be worth $1.00.You received no money for the establishment of the collar so you would have a $1.00 loss in the options. Meanwhile, the future options that you purchased at $28.50 is now worth $31.00 at expiration, which is a $2.50 gain.Combine the $2.50 gain in the future options with the $1.00 options loss; you have a $1.50 profit again. You may do this calculation with higher and higher future options prices but the outcome will always be the same. This example shows how your upside potential is limited.Obviously, if the option portion of the collar incurred a debit or credit, that inflow or outflow of money must be added to or subtracted from the future options gain to get the overall return of the position.Normally, there will be a debit or credit incurred in the collar. It is usually difficult to find a put and a call that you want to use in the collar trading at an equal value. Let’s use our last example with some minor price changes.If the put had been trading at $1.25 instead of $1.00, then there would be a $.25 capital outflow that would have to be subtracted from the $1.50 gain to reduce it to only a $1.25 gain.On the other hand, if the call was trading at $1.25 then you would have collected an extra $ .25 which added to the $1.50 gain would produce a $1.75 gain. The cost of the collar always impacts the bottom line profit or loss of the position.

The Protective Put Strategy & Forex Options

As a reminder, a put gives an owner the right but not the obligation to sell a certain forex options, at a specific price, by a specified date.For this opportunity, the buyer pays a premium. The seller, who receives the premium, is obligated to take delivery of the forex options should the buyer wish to sell the forex options at the strike price by the specified date. A strategically used put offers maximum protection against substantial loss.The Protective Put, also referred to as a “married put,” “puts and stock” or “bullets,” is an ideal strategy for an investor who wants full hedging coverage for their position.Whereas the Covered Call Strategy will cover an investor down only as far as the premium he receives, the protective put strategy will protect the investor from the breakeven point down to zero.This strategy's philosophy is different from the covered call (buy-write) strategy in two major ways.The covered call is a premium selling strategy, while the protective put is a premium purchasing strategy; and the covered call is most effective in a less volatile situation while the protective put is more effective in high volatility situations.When an investor purchases forex options, he can either sell the call (buy-write) or buy the put (protective put) to provide a proper hedge. The construction of the protective put position is actually quite simple. You buy the forex options and you buy the put on a one to one ratio meaning one put for every one hundred shares.Remember, one forex options contract is worth 100 shares. So, if we have 400 forex options in IBM then you would need to purchase exactly four puts.
Number of Shares Owned
Put Contracts to Buy
100
1
300
3
1700
17
9200
92
14500
145
267000
2670From a premium standpoint, we must keep in mind that by purchasing forex options, we are paying out money as opposed to collecting money. This means that our position must “outperform” the amount of money that we put out which is the opposite side of what we did in the covered call strategy.If we were to pay $1.00 for a put and we owned forex options against it, we would need to have the forex options increase in price $1.00 just for us to break even. Unlike the covered call, the protective put strategy has the premiums working against it, thus the forex options need to move more to offset the cost of the put.This is why long option strategies need more volatility than short option strategies. Earlier we talked about the covered call strategy needing to be done over a decent period of time (a year or so) in order to take advantage of the odds.We stated that selling forex options and collecting the premium was the right thing to do 75% – 82% of the time. If this is true, then buying forex options and paying out premiums is only going to be right 18% – 25% of the time.Those are not good odds. So, you should try to stay away from employing this strategy over a long period of time to avoid having the odds fall against you. However, employing a protective put can be extremely effective in the proper situation.Let’s take a look at the risks and rewards of the protective put strategy over three different scenarios:...

How The Stock Replacement Covered Call Strategy Work For Fair-Value Stock Options

We have demonstrated how well options function in unison with a stock position. They enhance potential gains and provide profit protection. They enable us to manage specific risk for fair-value stock options as well as an entire portfolio. But, as good as options are in conjunction with fair-value stock options, they can be even better when traded against each other.There are many option strategies that do not involve the use of any security other than another fair-value stock options, like spreads, straddles and strangles, for example.A spread involves the purchase of one option in conjunction with the sale of other fair-value stock options. There are many types of spreads. Some take advantage of fair-value stock options movements while others are set up to take advantage of implied volatility movements. Some are even designed to take advantage of a fair-value stock options staying still. There are vertical spreads, calendar or time spreads, diagonal spreads and ratio spreads just to name a few. Spreads can provide large percentage returns with low risk and can be entered into with small capital outlay.Straddles involve the buying (long) or selling (short) of a call and a put (usually at-the-money) in the same fair-value stock options, in the same expiration month, and the same strike.Strangles involve the buying (long) or selling (short) of an out-of-the-money call and an out-of-the-money put in the same fair-value stock options and in the same expiration month.These are both trades in which you can take advantage of fair-value stock options or volatility movements (in the case of being long) or lack of fair-value stock options or volatility movements (in the case of being short) during the period of time until expiration. Both straddles and strangles are considered premium precision plays.These trades are considered more advanced and sophisticated than the strategies previously discussed. Certain spreads, such as 1 to 1 vertical spreads, can actually be less risky than some of the strategies discussed above, but spreads generally do have more variables to consider, and this makes them more difficult to trade.The straddles and strangles sometimes involve much more risk and many more variables to take into consideration. So, these trades are considered very sophisticated and should not be entered into by untrained novices.

Construction of a Vertical Spread For Expensing Stock Options

Again we set time forward to Friday, July expiration. We set the expensing stock options closing price at $60.00. At $60.00, both the July 45 puts and the July 60 puts will be out of the money and thus worthless. With both the July 45 puts and July 60 puts worthless, the spread is also worthless (July 60 put $0 – July 45 put $0). If the expensing stock options finish at $52.50, then the July 60 puts will be worth $7.50 while the July 45 puts will still be worthless. In this scenario the July 45 – 60 put spread will be worth $7.50 (July 60 puts $7.50 – July 45 puts $0). If the expensing stock options finish at $45.00, then the July 60 puts will be worth $15.00 while the July 45 puts will be worth $0.At this level, the spread will be worth $15.00 (July 60 puts $15.00 – July 45 puts $0). This is the maximum value of the spread. As you can see it is identical to the $15.00 difference between the strikes. As the expensing stock options go lower, the July 45 puts become in-the-money and gain intrinsic value. Now, for every penny that the expensing stock options decrease in value, the July 60 puts and the July 45 puts will gain value equally, keeping the $15.00 spread between the two strikes constant. To see this, refer to the table below.As stated, the maximum value of a vertical spread is the difference between the two strikes while the minimum value of the spread is, of course, $0. This means that in this expensing stock options strategy, both the buyer and the seller have a limited, fixed maximum loss. The buyer can only lose what he spent. So, if the buyer spent $2.20 to purchase the August 35 – 40 call spread, the most he can lose is the $2.20 he spent.For the seller, the maximum loss is the difference between the maximum value of the expensing stock options spread (difference between the strikes) and the amount of money received for the sale of the spread. For example, if you were to sell the August 35 – 40 call spread for $2.20 then your maximum loss will be $2.80. Remember, the maximum value of the spread is the difference between the two strikes or $5.00 (40 – 35).
Stock Price
June 60 put value
July 45 put value
Spread

Donalds & Their Covered Call Options

NOTES ON DONALD’S (MCD) covered call options1. Around June 2, 2003, MCD breaks out through a resistance level established back in late Nov. early Dec. 2002 after failing to break that resistance level in mid May 2003.2. MCD climbs up from $20.00 to the $25.00 range in a slow gradual uptrend step like pattern. This type of pattern is an opportunity for buy-writers because this type of gradual rise normally brings about a decreasing implied volatility period which is great for premium selling.3. Notice the size of the daily vertical lines during the period from mid-August 2003 to December 2003. The size of the lines represents the daily trading range of the stock. As you can see, the lines are very short which indicates that the stock does not move much intra-day. Again, this is an indication of decreasing volatility which is a positive sign for buy-writers.Conclusion: The two most prominent and noticeable patterns both bode well for buy-writers. The covered call options strategy does not need a lack of movement, as much as slow, consistent non-volatile movement.So, in the case of McDonalds above, the slow trending movement of the stock brings about a decreasing volatility for the covered call options. Added to this is the contraction of intra-day movement, as shown by the decreasing range of daily trading.These two factors each contribute to decreasing volatility and provide an opportune time to write a covered call for the covered call options. This is the type of pattern that offers both capital appreciation as well as premium returns.