Be aware of Economic Reports before entering into a trade.

- John Garrity

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October 30, 2007

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There is a two day FOMC meeting that starts today. On Halloween around 1:15pm central time something scary could come out. Don't be scared - I'm here to help. All joking aside, this could be one of the most important Fed Meetings of recent history. The Dollar being at all time low's, the Energies at all time high's, and quite a few other Commodities being at extremely high levels. What is going to be said? Is there going to be an Interest Rate cut? If so, how will this effect the Stock market? Will Commodity prices continue to soar above the clouds or fall like a stone? We should have some answers to some of these questions on Wednesday afternoon, of all days, Halloween!

Ben Bernanke has three choices on Interest Rates: No cut, cut 25 basis points, or cut 50 basis points. The 1^st and 3^rd choices will most likely provide the most volatility, although, whatever action is taken will most likely provide a lot of movement in the commodity sector, in my opinion. I will go over a few scenarios that could help the individual investor. The way the markets move this day and age is spooky at times. It will occasionally scare the little guy out of his shirt if he is not careful. I will talk about three different countertrend option strategies in Crude Oil, starting with the spookiest. I will also talk about being a countertrend option trader in Gold, Dollar, and Soybeans.

Spookiest (limited potential with limited reward)

Crude Oil is trading at all time high levels around $93/barrel. You believe prices will most likely head a little higher to maybe $100/barrel, but you also believe the $70/barrel price is most likely in 6 months. You decide that you would like to sell some April Crude Oil 100/calls for a credit of about $2500 credit per option. Your potential gross gain is limited to $2500 per option sold. If Crude Oil prices are trading under 100/barrel at expiration you will be able to keep your entire premium you collected. Your risk is unlimited on your naked 100/calls. Whenever I sell a naked option I set up a risk tolerance ahead of time. There is no assurance you will be able to get out with that type of risk. You don’t want to go away for the Holiday’s and come back and Crude Oil prices are $110/barrel.

Spookier (limited potential with limited reward)

With this scenario you again think the price will eventually head towards $70/barrel in 6 months. You want to stick with selling premium, but you do not want to be naked short the option. You never know, there could be some armed conflict that ensues and the oil market blasts off. You decide to sell the April Crude Oil 96/100 call spread for a credit of about $1000 per call spread. Your potential is limited to $1000 per credit spread sold. Your risk is the difference in the strike prices, less the amount collected, which will be $3,000 in this example. If April Crude Oil settles above $100/barrel at expiration you will lose $3,000 per credit spread. If April Crude Oil settles below $96/barrel you will get to keep your $1000 credit you received.

Spooky (unlimited potential with limited risk)

You purchase the April Crude Oil 78/put for $1500. If Crude Oil drops to $70/barrel by expiration you will get $8000 (the difference between 78 and 70) - $1500 (cost of 78/put) = $6500 profit per option.

Here are a few Spooky strategies for the countertrend trader on Gold, Dollar, and Soybeans:

Dollar

Our US Dollar is trading at all time lows, around 7600. Let’s say you believe the Dollar will regain strength by the summer of 2008 and it will be trading back to 9000. You do not want to risk anymore than $1500.

Option Strategy #1

The June Dollar Index 76/call options are $1500. If the June US Dollar Index is trading at 9000 at expiration you gross a profit of about $12,500 per option purchased.

Gold

Gold is trading at almost $800/oz. Let’s say you believe by the Summer Gold is going to retreat back to $600/oz. You do not want to risk anymore than $1500.

Option Strategy #2

The August Gold 740/put will cost about $1500. If August Gold is trading at 600/oz at expiration you will make about $12,500 per option.

Soybeans

March Soybeans are trading around $10.40/bushel, a contract high for the year. Let’s say you believe prices are going back down to $8.00/bushel. Your risk tolerance is $1500.

Option Strategy #3

The May Soybean 940/put is about $1500 cost and risk. If May Soybeans are trading at 800 at expiration each option would be worth $7000, netting close to $5500.

The Gold, Dollar, and Soybean Option Strategies are very basic. You are bucking the trend. You are setting a monetary risk and you are setting a time frame. This could be for speculation or you could be hedging a position you are holding. The good thing about these strategies is you know what your risk is and you also know your time frame. You are not exposed for more than you invest and your potential is unlimited. You have the right to exit these positions at anytime for an amount equal to the prevailing premium at time of the exit.

All I have talked about is going against trend. Going against the trend is usually more wrong than right. The trend is your friend and the market is rarely wrong. The market is where it is at for a reason. That said, if you believe markets tends to move back into more historical price equilibriums, you may wish to buck the trend and buy Put options in a bull market, or Call options in a bearish market. Be ready for those healthy corrections, to pull out some profits, as all you may get is a correction. At times you could get a trend reversal and that is when you could make big money. It could be a good idea to purchase multiple contracts of options, so if you do have that correction you could pull off a portion of your contracts for a profit. You may then hold your remaining contracts, which hopefully you have already paid for on your realized profits from selling part of your position during the correction, for the trend reversal.

In the theme of Halloween I decided on taking a countertrend theory. I also do believe the prices of the above Commodities are unsustainably high and due for at least a correction. I think these Commodities have risen too high too fast. It’s a common perception that falling markets usually will drop a lot faster than they rally. I generally believe in going with the trend of a market, but in the above Commodities I would wait for a correction before I went long. Will the market trick you this year or will you get a treat??

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!