Martin Kronicle

Paul Tudor Jones said “I always believe that prices move first and the fundamentals come second.” – from Market Wizards by Jack Schwager

Remember that quote…

According a NYT article U.S. Farmers Plan a Record Soybean Planting, “American farmers expect to plant 88.8 million acres of corn — the second-largest acreage since 1946 — and a record 78.1 million acres of soybeans in response to high prices for the crops, the government said on Wednesday.”

High prices cure high prices…

The article also stated that “the Department of Agriculture said there were 7.69 billion bushels of corn in warehouses and grain bins on March 1, the largest amount since 1987 and more than was expected by traders.”

Here is the chart of the December Corn contract. The two red arrows indicate the dates March 1 and March 31. (Click to enlarge)

Here is the chart of November Soybeans. The two red arrows indicate the dates March 1 and March 31. (Click to enlarge)

A couple of things could have happened here:

1) Speculators drove down the prices by selling corn and soybeans short. Speculators hereby aid consumers.

2) Producers, noting higher prices in Q4, decided to concurrently sell futures and plant to capture higher potential profits.

Regardless what you may think, you MUST follow the price first.

Why? Well remember to look at the two red arrows: The first (on the left) is the March 1 date of the crop report from the DOA stating the potential for bumper crops in corn and soybeans. The red line on the right of both charts signifies the date of the NYT article – a month later – March 31.

I would state that both the March 1 DOA Report and the March 31 NYT article are lagging indicators, from a trader’s perspective, so to speak. They are not technical indicators, of course.

Most importantly, during Q4 2009, farmers (hedgers) had a sense of prices, supply, and demand and acted accordingly. They have perfect knowledge of what supply they can supply above what the rest of the market can only estimate.

Prices move first, and fundamentals follow. Had you been long waiting for the news, you’d be sitting in losses. Had you been long but placed protective sell stop orders in, you’d now come to understand why you got stopped out for small losses – and you’d have more cash in your account.

Protect your capital at all times.

How Venezuela Can Have Their $80 – $100 Crude Oil Price Band: A lesson on Collars

BusinessWeek reported that Venezuela wants to keep Crude Oil in a $80 and $100 price band. Producers can affect this price band with what are known as price collars using options on crude oil futures contracts.

Venezuelan Oil Minister Ramirez can create a collar around $80 and $100 to insure that Venezuela can transact their crude oil in this band for quite some time. Venezuela is the OPEC’s 6th largest producer.

If he wanted to create the 80/100 price band, he would do the following (prices based on today’s settlement):

Buy the July 8000 Put which settled at $1.64 and sell the 10000 Call which settled at $0.82. So, in this case, the collar would cost Venezuela $0.82 per collar or $820 each ($1.64 – $0.82). That’s the most they can lose – the price they pay.

[Decimals aren't used on the strike prices, so 8000 means $80.00, 10000 means $100.00, and 9550 means $95.50.]

For $820 today, Venezuela can insure than they will receive no less than $80 per barrel, but in return for a lower cost of “insurance” they forsake any upside above $100 – that’s because they take in $0.82 for selling the 10000 Call. The option contracts are based upon futures prices and their standardized size of 1,000 barrels.

To take advantage of $100+ crude oil beyond what they collar, Venezuela can produce more crude oil OR only collar up part of their expected production in the first place. Venezuela is said to be “capped” above $100 because they’ve obligated themselves to deliver the crude at $100 via the Strike Price of the Call option.

Venezuela can do it even cheaper, however, if they were willing to forsake a lower cap – lower than $100. Such a strategy would be called a “zero-cost collar” as Venezuela would only have to post margin (hedger margin which is lower than investor margin since they produce crude).

In this case, they would purchase the July 8000 Put and sell the July 9550 Call. At today’s close, both options coincidentally settled at $1.64, so what they pay for one will be offset by the sale of the other, hence “zero-cost.”

In fact, Venezuela can do this out to July 2011 also (and way out on the calendar for that matter). The July 2011 8000 Put goes for $6.92 and the 10000 Call went off at $6.70 for a net debit of $0.22 per collar, or $220 for every 1,000 barrels.

If Venezuela (or any other crude oil producer) were willing to sell the 9900 Call (instead of the 10000 Call), they could get $7.01 at today’s close, making the collar trade a net credit of $0.09 per collar, $90 of income to put on the collar!

Admittedly, the bid-ask spreads on everything get wider the further you go out on the calendar. I’m not sure that Venezuela could actually get paid $90 to have this protection, b/c it might get “eaten” during the transaction, but you get the picture.

I’ve done a few interviews with guys who really know the option space very well. Listen to my podcast interview with Tony Saliba and read my Gold Spread analysis, and watch Victor Sperandeo on Implied Volatility.

Question for my students: Who could be on the other side of any of these trades, and what is their market posture for crude oil?

All prices came from the CME Group and their awesome site.

I was very fortunate to have taken several classes with Robert Mundell. Mundell had a lot to do with inspiring me to trade commodities and the interbank.

Mundell is going to be on a panel with Nouriel Roubini at the Milken Institute’s Global Conference later this month called “The Eurozone: Still One for All and All for One?”

Here is the description of the panel from the MI website:

The debt crisis in Greece has seriously frayed the ties that bind the Eurozone together with a monetary union but without fiscal transfers. Unable to afford the expensive social programs its citizens demand while staying within the Eurozone’s debt limits, Greece can neither raise import tariffs nor devalue its currency. The stronger member nations — especially Germany — are torn between their distaste for a bailout and the need to prevent the crisis from spiraling any further. Is there a need to create a European Monetary Fund? Will the euro manage to recover? Do ballooning deficits in Spain, Italy and Portugal signal further storms on the horizon? This panel of experts will explore whether the Eurozone can forge a successful system of joint economic governance.

You can watch the Robert Mundell Bloomberg interview. It’s long, but great!

In order to feed your brain, you actually have to feed it. You do that by reading, not listening. It’s true that we learn by listening and writing also, but reading is the most fundamental and economically viable way to learn for most of us.

Most all of the major traders/wizards that I have met are voracious readers: they read everything. Two of them that I know very well and whose houses I’ve been to don’t have bookshelves…they have book-ROOMS…with titles on commodities that go back to the beginning of the century. Heaven!!!

Here are my favorite books from 2009.

According to The Economist, e-books and e-publishing are the future. Maybe this is slightly hyped b/c of the iPad launch, but consider this: with RSS readers and ebooks, online magazines, and online newspapers you technically don’t need to buy any paper-based reading material anymore…unless you like the feeling of holding a book.

I like books, but I love my RSS Readers and Kindle too. They allow me to consume an enormous amount of material in much shorter periods of time than if I had to hold the written material on paper. I read as much as any CIA analyst.

So each day, I read from my RSS Reader, my Kindle, books, and Twitter search results. And when I’m done with all of that, I’m looking through Gutenberg Project for free things to read that I can upload to my Kindle. One gem I’ll give you for free that I uploaded to the Kindle was Fiat Money Inflation in France by Andrew Dickson White. A very timely read indeed.

From The Economist:

“Like many other parts of the media industry, publishing is being radically reshaped by the growth of the internet. Online retailers are already among the biggest distributors of books. Now e-books threaten to undermine sales of the old-fashioned kind. In response, publishers are trying to shore up their conventional business while preparing for a future in which e-books will represent a much bigger chunk of sales.”

The amount of sales now is tiny of overall book sales – 6%. But once the word gets out about how much you can get for free on the internet AND once Google gets involved, you’ll see competition for better devices and lower costs for books (unless they collude).

To avoid volatility, stop trading – Ed Seykota

Bloomberg reported on the IEF meeting in Cancun in an article called “OPEC, IEA, IEF to Unveil Measure to Combat Oil-Price Volatility.”

After reading the article a few times, I’m of the mind that the market knows more than any bureaucrat or government agency here or elsewhere.

Here is one thing that I believe will lower volatility in crude oil futures trading:

1. Lower margin requirements to allow for more participants, therefore, increased liquidity.

As far as everything else listed in the article, it’s all political, biased, and agenda-based. I don’t know who of the CFTC, FIA, or MFA was at the conference in Cancun.

As far as peak oil is concerned, demand for crude did wane, but production fell faster. Who controls production and what incentive do they have to be “open and honest” with their counterparts, or in the case of OPEC, other member nations?

2. Implied volatility tells you nothing about the future – it’s not predictive at all.

3. American driving patterns and heating oil consumption are seasonal, and are fairly predictable year over year. Who is Secretary El-Badri of OPEC kidding? He applauded the U.S. for “putting some brakes on speculation. It’s a positive step in the right direction.”

Really? How about creating a standard within OPEC to consistently meet the world’s needs for crude oil and it’s distillates.

4. OPEC is the world’s largest commodity pool and isolated group of speculators on the planet. Collectively, they control 40% of the world’s oil. I don’t think anyone at the CFTC thinks of them that way though, probably b/c they can’t regulate them.

High prices cure high prices. We have to live with the fact that OPEC members can turn the spigot on an off at will.

Regarding CFTC Limits

“The U.S. Commodity Futures Trading Commission, which oversees more than $5 trillion in daily trading, in January proposed adding limits to the energy markets as part of a government campaign to prevent individuals or companies from gaining too much control of a commodity market.”

5. Individuals and companies don’t want to control an expiration month or several of them. It’s too illiquid and can lead to catastrophic losses. The US commodities markets have never had such a meltdown such as the subprime morass.