The crude oil sell off has been vicious both in its depth and its speed. In fact, the market has been so negative that we last wrote about it this past June 11th. The market had provided a bit of a rally in the face a growing and overwhelmingly bearish commercial trader position which led to our headline, “Sell Crude at $65 Per Barrel.” Our primary focus is based on the Commodity Futures Trading Commission’s weekly Commitments of Traders report. We use the actions of the commercial traders to help us determine value in the commodity markets like the buying opportunity in gold that we published in Futures Magazine on august 7th. Bringing this back to crude oil, here are three charts that show the crude oil market is nearing a bottom.
Twenty years of trading has proven one thing correct, time and time again. The markets act in such a way as to do the greatest amount of harm to the greatest number of participants at any given moment. This is exactly how Sunday night’s trading began when, for a few minutes, traders were able to trade gold and platinum at the same prices. There were two opportunities on Sunday night. The first was shortly after the open and the second was around 2am Eastern time as you can see on the chart below.
Many customers have been asking spread strategy questions
and last week’s action in the gold and platinum markets provides us with a
wonderful opportunity to have this discussion.
Take a look at the
The red line on the
bottom is how much gold is worth relative to platinum (gold close/platinum
close). This is a monthly chart and you can see that the spread, along with
platinum, have broken their trends going back to ’01. This means that the
prices of these two metals are converging. One should be short platinum and
long gold. The way I see it, the price of platinum has been beaten up far worse
than gold. I think the global slow- down scenario may be impacting the
manufacturing base for platinum more than inflationary/deflationary issues are
effecting the speculative nature of the gold market. Gold has also held above
its trend line, in spite of the U.S. Dollar’s significant rally.
Profitable spread trading requires more than predicting the
general directions of the two markets involved. The size of the contracts, tick
size and volatility also need to be considered. In this example, there is only
one platinum contract to choose from. However, there are four actively traded gold
contracts in three different sizes and on two different exchanges. Even the simple
assumption that one full size contract of each should be sufficient would be
incorrect. Recently, platinum is moving around $67 per day in the futures
market and gold is moving around $25 per day. Would it be appropriate to try to
even these out by trading two gold contracts versus one platinum contract?
Here is the method I use as a commodity broker to appropriately size my spread
trades. First of all, I calculate the average range for each market relative to
the time frame I expect my trade occur in. In this case, I am looking at
monthly charts. Therefore, I calculate the 21 day average range for each market
and come up with $21 for gold and $67 for platinum. The next step is to
multiply each of these average daily ranges by the market’s point value. Gold
is $21 X $100 = $2100 per day average movement. Platinum gives us $67 X 50 =
$3350 in average per day movement.
Clearly, one full
size contract of each is not an even spread. Now, since we know that we only
have one platinum contract to work with, our only opportunity for proper sizing
in the futures market (there are option strategies available, as well), is to look
at the list of available gold contracts. One full size gold contract gets us to
$2100 per day and leaves us with a $1200 per day deficit to make up. Chicago’s mini
sized gold contract is 33.2 oz. (1/3 full size). That would bring our total to $2793
on the gold side of the trade. This won’t square the ledger. New York’s mini
sized gold contract is 50 oz. (1/2 full size). That would make our total $3150.
That’s pretty close. Obviously, the other option is to use two Chicago mini
contracts and bring our total to $3486. At this point, it comes down to
personal bias. Would one rather be more or, less long gold relative to
I hope this brief description answers more questions than it
creates. However, please feel free to post any ideas, comments or, issues.