WINNING IN FUTURES
Prepared by Opportunities In Options
(May 18, 2000) The interest rate markets may be looking ahead to the end of monetary tightening after one or two more rate hikes. This could start to narrow the calendar spreads in Eurodollar futures.
Observers of the interest-rate markets often use the Eurodollar and Fed Fund futures contracts to gauge the market's expectations for future monetary policy. After all, this is where huge sums of money are placed in order to hedge perceived or potential risk in an ever-changing interest-rate environment. In my experience, the "opinion" of these two futures contracts about "what the Fed is going to do" is far more valuable than the whole group of talking heads that we are relentlessly subjected to in the financial media. It reminds me of that old saying "economists exist to make weathermen look good." Most commentators don't have too much riding on their opinion, but the futures markets have their money where their mouth is, and they voice their opinion through market prices. They don't waste time changing their opinion (and the direction of prices) when a fundamental shift starts to be perceived. The calendar spreads between Eurodollar contracts can also be used to gauge what the market thinks of both the direction of future rate changes, and the degree.
Here's the comment of the week: In a recent interview with Bill Gross, the head guy at the PIMCO group of funds, the interviewer stated that interpreting and trading the financials was like playing "an increasingly complex 3-dimensional chess game." In this current environment of an inverted yield curve in our domestic treasury market, and changing global market dynamics, this certainly seems to be the case. Mr. Gross's opinion usually is one of value, and he's definitely got a lot riding on his opinion. In brief, he expects a couple more small tightenings from the Fed in the next two meetings, which might be enough to accomplish their monetary objectives. The interest rate futures still project further tightenings beyond that, but if that perception changes, the longer-term futures will start to recover.
If the market starts to perceive an end to tighter policy after a couple more hikes, it would tend to narrow the gap between the nearby Eurodollar contracts and those two or three quarters further out. During the last nine months of the current environment of tighter policy, the market has showed expectations that there would be somewhere between 25 and 50 basis points of additional tightening between September of 2000, and June of 2001. If market expectations change for continued tightenings beyond the middle of this year, this spread could narrow quickly and approach the 0 level.
In the interest-rate markets of the last few years, the financial futures are usually "ahead of the Fed" in figuring out fundamental changes that will influence monetary policy at the Federal Reserve. Further, it is generally the Fed's policy to "give the market what it expects," probably for two reasons. First, the Fed doesn't like to roil the markets with surprise moves, and knows that meeting expectations will cause the least disruption in the marketplace. Second, what the market is already expecting is usually what the Fed wants to do anyway. If the "consensus opinion" formed by the financial futures is almost universally convinced of a certain amount of policy change (or no change), that's usually what's going to happen. Sometimes the expectations are split down the middle as to whether there will be a move or not (or the amount), and the most recent economic data can have shift expectations up to the last minute.
It was an easy speculation that the Fed was going to hike rates a full 50 basis points at this last meeting (even though this was the biggest hike in 5 years), because the markets had already factored it in. Right before the meeting, the June Fed funds (which will fully reflect changes from the May meeting), showed a 90% conviction that we'd see a 50 basis point hike. Eurodollars were of similar opinion.
Consider the futures spread that's long the June 2001 Eurodollar futures/short September 1999. The posted margin from the CME is $304 per spread. The spread last settled with September Eurodollars at 32 basis points premium to the June (putting the spread chart at minus 32). You can take the spread near current levels, or wait for a small reaction and try to get in at about the 35 level. Suggested risk is about 10 basis points ($250) in the spread. Our first trading objective is for the spread to break out to new short-term highs and narrow to less than 25 basis points September premium. If that first objective is reached, the trailing stop would be tightened up. Some clients already started to do these spreads on Wednesday, with fills coming back in the 32 to 35 range. Each basis point move in Eurodollars is worth $25.
The CME ranks the margin requirements on intra-market calendar spreads in the Eurodollar futures based on the time distance between the contracts, called "tiers." Each tier consists of at least one futures month (quarterly), and includes the serial months (monthly). The first four tiers are laid out like this:
Tier 1 is months 1-4 (i.e., the current front month June through September),
Tier 2 is months 5-8,
Tier 3 is months 9-12,
Tier 4 is months 13-16, and it goes on like this in 4-month tiers.
The margin is calculated based on which tiers are involved in the spread. For example, a spread between two contracts that are both in tier 1 would have a margin of $203. Between tier 1 and either tier 2 or 3 is $473, and between tier 1 and 4 it's $304. The spread suggested here would be between tier 1 (September, month #4 forward), and tier 4 (June 2001 contract, month #13 forward).
Open Trade Review (Some Trades May Be Suitable For New Entries)
Some previous positions may offer new trading opportunities if indicated, or variations may be suggested. Also check for adjustments, revised profit targets or risk stops. The most recent trades are usually reviewed first, or grouped within market sectors. Trades are deleted if profit targets or risk stops are hit, or given a final review if time and space permit.
Due to time and space limitations, some coverage is abbreviated this week.
LONG DECEMBER CBOT WHEAT/SHORT DECEMBER CBOT CORN
This spread was introduced two weeks ago, pointing out that it was at extremely depressed levels in wheat relative to corn, especially for this time of year. Although it was early timing for a "seasonal" turn in the spread, it might have already made its low for the year.
After we introduced the spread, it immediately started its best rally in a year, up 25 cents from the lows. Last week before the USDA report, it was suggested that aggressive traders could take trades ahead of the report, and entries last Thursday should have been in the 42-45 cent range. The spread closed as high as 54-1/2 cents wheat premium this Tuesday. For any early trades, we would suggest taking small profits now, or at least moving stops near the entry level. Remember that this spread is still under "seasonal" pressure that favors the corn for a few more weeks, and taking small swings out will probably be the preferred way to trade it for a while.
For new trades in the December wheat/corn spread, consider entries on pullbacks. The first strong thrust that this spread made from the lows is positive technically, and may be a clue that fundamentals are changing and that a better wheat premium will be warranted in the months ahead. We see the potential for this spread to develop into a "trading channel" type of scenario, in which trading swings from the bottom to top will be an effective plan. That's what happened last year, when trading the swings from May until September worked pretty well.
Consider entries in the long December wheat/short corn (CBOT) futures spread on pullbacks into the 45-40 cent area, wheat premium. The margin is about $1300, allowing full margin for both contracts in the spread. Suggested risk is about 10 cents from entry, or to a close at 29 or lower.
Also, the wheat market by itself has improving technicals and fundamentals, and traders should consider entries into long positions, such as December option spreads that were suggested before.
LONG AUGUST SOYBEAN MEAL/SHORT AUGUST SOYBEAN OIL
This trade was featured four weeks ago, and triggered entries when it broke out above the downtrend. It easily reached $2000 in profit since the breakout, and partial profits were suggested for multiple positions. It's tracked as an equity spread because the contracts trade at different point values.
The seasonal pattern can be favorable all the way into July, and another "optimal" seasonal entry point comes near the end of May. Move the trailing profit stop up to a close below $7000 meal premium. Traders with single positions should also consider taking profits at about the $8500 level, if reached.
The current correction could provide a good entry opportunity if the spread puts in a low in the $7500-7000 range.
Other Grain Positions
Weather has obviously been the driving force behind the short-term moves in the grain markets. Recent rains have given us a normal pullback, while longer-range forecasts for dry conditions and good demand should keep a floor under prices. 30- and 90-day forecasts are expected after Thursday's market close, and the outlook is expected to be for hot and dry conditions.
Use the current pullbacks for entries into the corn, soybean, and wheat markets.
Based on low price levels, improving global supply/demand fundamentals, and technical patterns, the wheat market is a compelling case for long positions. Also, seasonal patterns will start to improve after a few more weeks. We already have plenty of open positions in December 300-350 call spreads, and some that combined those spreads with 280-260 put credit spreads when the market tested its lows in late April. We nailed a good entry at near even money into this trade, and it's ahead by about 6 cents now. There was also another dip after the rally off the lows that provided opportunities to sell the put spreads according to suggestions that were made in the letter.
Continue to consider the December wheat 300-350 call spread near current levels near current levels. Last settle 12-3/4 cents, with WZ at 303-3/4. After a good rally, we can evaluate selling other premium and turning these into ratio spreads, or other adjustments.
In corn, consider the December 250-300 call spread at up to 14 cents. The last settle was 13 cents, with CZ at 253-1/2. This has been an ongoing trade, and has moved back into the entry area. We'll evaluate selling other premium against it on rallies.
In soybeans, consider the November 550-650 call spread at about 20 cents on any further pullback. It last settled at 23-1/4, with SX at 553.
There are also open ratio calendar positions in July/September soybeans and corn, and recent rallies gave opportunities to convert previous trades into similar positions by selling extra July premium. We'll do a more thorough review soon. They should all be near the entry area, and are well situated for any upcoming rallies.
In futures/options trades in grains, profit targets were hit during the last 3 weeks for soybean and corn positions. In wheat, there's still an open trade that's long July wheat futures at 275 or lower, short the July 310 or 320 call, and long a July 270 or 260 put as a downside hedge. Put hedges could have been dropped after the positive reversal from testing support, as was suggested. Move the sell stop on the futures up to 265.
LONG JUNE LEAN HOGS/SHORT JULY PORK BELLIES
First suggested 9 weeks ago in mid-March. Quick profits were accumulated on the rally to -1600 ($1200-1600). New trades were triggered during the last 7 weeks at the area below -2000. The spread is showing profits of about $1600, and the sustained breakout above resistance is bullish.
Favorable seasonal patterns for this spread can run until late May. Partial profits should have already been taken at 1600 points bellies premium ($1600 profit) for multiples. Move trailing stops up to closes below -1800.
Coffee
Bull call spreads (110-125 and 105-120) and bull put spreads (100-95) in July coffee have been triggered during the last eight weeks. These types of trades all have defined risk. July coffee options expire 3 weeks from Friday.
The next ACPC meeting is scheduled for this Friday. If the market isn't starting to improve by next Tuesday, look to close these trades on small rallies.
Orange Juice
This market has been trading in an extremely tight range for the entire year. The closing range for the July contract has been between 7945 and 8600 for five months. There are open positions in July 85 and 90-cent calls that expire 4 weeks from Friday. They last settled at 125 and 35 points. If July orange juice moves back above 8400 (even intraday), and then closes back below 8200, close all long July calls.
Consider buying November 90 or 100 calls if July orange juice closes above 8400.
LONG JULY ORANGE JUICE/SHORT NOVEMBER ORANGE JUICE
Suggested ten weeks ago at even money, and it's been in a tight range ever since. Last settled at -50, or 50 points premium to November, a small drawdown. Close these spreads at the entry area if given the chance, and keep the risk stop at a close over 100 points November premium. In orange juice, 100 points = $150.
Cocoa
There are open call spreads (800-950 and 800-1000) in July that can be held. July options expire 2 weeks from Friday. Some of these trades were also temporarily converted into ratio spreads which reduced the total trade cost.
There are also short 800 puts in July, sold at 35 points or higher ($350+). They last settled at 15, with CCN at 821. Hold. Close them and take profits if they drop to 10 points (they've closed as low as 12).
New trades into short puts were triggered in selling September 750 puts at 30 points ($300) or higher during the last two weeks. They last settled at 22, with CCU at 850. September cocoa options expire in 11 weeks. Continue to consider these for new trades. Do this only if you understand the risk of short premium and are willing to take the futures as a "value play" if assigned. The margin is about $500 plus the premium collected, but we recommend allowing a full futures margin of about $850 per option sold. See the April 13 letter for a more extensive discussion about selling put premium in depressed commodity markets that are near long-term historical price support.
We previously had two successful campaigns of selling puts in March and May cocoa options.
LONG JUNE MINI-NASDAQ/SHORT JUNE MINI-S&P
This spread was introduced in early March as a way to trade the market swings between the "new economy" stocks and the old, speculating that the technology sector had gotten too far ahead of the rest of the market. Several very profitable guidelines were suggested as the spread moved down in three legs for a total drop of about $25,000 in value as the market took some of the air out of the technology sector. There have been no suggestions for several weeks, as the spread action and the market started to get choppy. The chart will be updated in one of the next two letters.
May 18, 2000 Holger M. Laubmeier Opportunities In Options Financial Plaza, 300 Esplanada Drive, Ste. 200, Oxnard, California 800-926-0926 www.oio.com
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