Make sure you set your risk and an objective before entering into a trade.

- John Garrity

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June 6, 2007

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Peer into the analysis and share in the opinion of market veteran John Garrity when you receive the Garrity Report. Twice daily you will receive via email his market commentary and experienced analysis of the futures and futures options markets. The Garrity Report delivers a concise technical and fundamental opinion of the markets that are moving. Sign up today for The Garrity Report and receive 2 weeks complimentary!

In the spirit of Pirates of the Caribbean and other such takes on the search for treasure and amazing returns, I’d like to lead you to and through some of the adventures we foresee scattered about on the map of the commodity and financial futures markets.

Let’s start this journey with the equity indexes – what a great ride! There is an excitement again when looking at one’s stock portfolio. What I hear a lot of people saying right now is that they never would have dreamed that their IRAs and such could go up so much in one year. Who wants to trade commodities right now if it’s “easy money” times in the stock market?

Who? Well, anyone who lived through the bubble pop five years ago, that’s who. Just like a ship on high seas, we have experienced that what goes up eventually will come down, and falling markets tend to break a lot faster than they rally. I would like to present my opinion on the potential for a break in the stock market and how such a break might impact a few commodities.

Let’s take a look at what happened in late February to the equity markets. If the stock market begins to sustain a break, how might we hedge a portfolio? I can't tell you the perfect hedge because each portfolio may be different. In my opinion and as a general rule, though, for every $50,000 in a stock portfolio one should consider selling one Mini- Dow Jones futures contract. Let's crunch some numbers: Since 2001 the Dow Jones has moved from about 7180 to 13705. It has almost doubled in value. This is a move of about $65,000 for one contract in the Dow Jones futures. A 50% retracement is 10442. If you sell one Dow Jones contract and it breaks to the 50% level, it is a gain of about $32,000. Over the last year the Dow Jones has moved from 10730 to 13705. A 50% retracement would be 12220. If you sell one Dow Jones contract and it breaks to the 50% level, it is a gain of about $16,000. In all trading, timing is everything, so you’ll want to see the market continue any weakness or stop the loss on the position as early as possible.

Over the last decade the 30-Year Bond has had a nice rally -- A good bull chart pattern. Also over the last decade or so between the months of June to October the 30-Year Bond appears to rally more times than it breaks. Generally if the stock market breaks the bond market will rally. People pull some money out of the Stock market and put it into the Bond market as a safe haven. For example: take a look again at late February. As the Stock market hit its lows of the year the Bond market was putting in its highs of the year. The December Bond 112/call is about $400 and the September 10/Year Note 106/call is approximately $600? It's like trading a Future without the worry of getting stopped out. This is an at-the-money Call Option.

I am not saying to sell the stock market and buy the bond market. This would be bucking both trends. The trend is generally your friend. If you go with the flow you will usually be right more times than wrong, in my opinion, although it sure is tempting to try and pick tops and bottoms. The Equities and Interest Rates are the most widely traded markets in the world. If a market trades a lot of contracts it is generally very liquid and for the most part allows you to move into and out of the market fairly easily. That said, even liquid markets can be costly to exit when they’re in fast markets. Slippage due to technological issues and holes in the inventory, to name a couple, can increase the risk of a trade substantially. Another approach I employ when considering a potentially drastic move against a position is the use of options as a hedge. Buying call options or put options is a way to protect yourself that allows a trader to know what the risk is going into a trade, and eliminates concerns about major slippage a stop loss order might incur. For example: You want to hedge your Stock Portfolio. You sell the June Dow Jones at 13700 and you buy the June Dow Jones 137/call for a cost of $2500. Your risk on this trade is $2500. Your worst case scenario is if the Dow Jones settles at 13700 on expiration you are out the cost of your protective call, $2500. Your potential is unlimited on the downside.

I also believe some of the other commodity sectors could get hurt if the stock market cracks. I am going to stress the late February break again, February 27th to be exact. The Grains, Metals, and our Dollar got hit. Prices broke considerably. The European Currencies favored fairly well. I don’t see much impact on the Meats, Softs, or Energies. Who wants to buy Put options in the Grains right now? Answer: not many speculators. If you look back over the last decade or so, the Grains usually break in price between the summer and fall: Harvest Pressure. We are seeing some of the highest prices in over a decade, so if they do break in price this could be the year you might make a lot of money. The summer is very choppy because of the weather, so in my opinion it is very hard to predict short term price action during the Summer. If you buy Put Options with plenty of time the odds are in your favor that the Grain prices will break going into the fall. I just picked a few Put Options in Wheat, Corn, and Soybeans with time. The March Wheat 460/put is about $550. The March Corn 320/put is about $550. The March Soybean 720/put is $600. Buying Put Options has limited risk with unlimited potential. You could also sell Call premium. The March out of the money Call Options have a lot of value. This is a strategy that offers limited gain and potentially unlimited risk.

What about the Softs? Orange Juice looks bearish technically, but don’t forget about Hurricane season. Buying Call Options going into Hurricane season could be very profitable. I don’t like to wish devastation on anything, but? Sugar has been the bear of the year. Every rally has been hit with massive selling. You might think this is as low as it could go, but than it goes lower. Sugar does tend to rally this time of year. It might not be a bad idea to buy the Future and back it up with a Put option for protection. Cotton looks like there has been a 1-2-3 bottom put in. This is a bullish chart pattern. I don’t see much to stop it from going to 8500, the highs back in October of 2003, in the long run.  The price of just about everything goes up over time. It’s simple Economics. It’s Inflation. It looks like it could be Cotton’s turn. Coffee looks like it could be heading higher technically, but there is usually pressure on prices as we get close to harvest. Lumber also looks good technically to the upside, but there is usually pressure this time of year. The housing market isn’t on fire. Cocoa looks like a bull market. In the long run I don’t see why it shouldn’t test the highs from 2003 of about 2400.

We’ve worked our way around the map and covered a lot of ground here in this article, touching on both financial and commodity futures in broad strokes. The first half of 2007 is nearing its end, and in the weeks of July we will be showered with corporate earnings announcements and forward guidance. Regardless of the upbeat or downbeat take on those numbers, opportunities abound not only in the equity markets but also in the commodity markets. The smooth sailing experienced in the stock market may hit some rough seas, and we’ll be keeping an eye out for potentially profitable moves in the commodity markets.

Since his arrival in Futures and Options in 1995, John Garrity has served as an equity raiser, currency analyst, and has trained hundreds of clients in the art of trading. Mr. Garrity provides all of his clients with a fundamental and technical analysis on various markets by writing a daily Garrity Report that is e-mailed twice each trading day. Mr. Garrity comes from a family with over 30 years of experience in the agricultural markets. His Father trades at the Chicago Mercantile Exchange in the Meats.

It's time you signed up for The Garrity Report!

Peer into the analysis and share in the opinion of market veteran John Garrity when you receive the Garrity Report. Twice daily you will receive via email his market commentary and experienced analysis of the futures and futures options markets. The Garrity Report delivers a concise technical and fundamental opinion of the markets that are moving. Sign up today for The Garrity Report and receive 2 weeks complimentary!