The Perfect Safety Net for the Oil Market
Two weeks ago, I discussed a few of the basics of commodities trading. Today and Tuesday, I’ll discuss the current state of four of the most popularly traded commodities: crude oil, gold, soybeans and corn.
Of course, crude oil and gold get the lion’s share of media attention. That makes sense, considering they account for a large portion of the volume traded on their respective exchanges – the New York Mercantile Exchange (NYMEX) and the Commodities Exchange (COMEX).
Soybeans and corn also are hot commodities. Literally hot, currently, with the extreme heat we’ve experienced over the last three weeks. As my colleague, Matthew Weinschenk, pointed out on Tuesday, the threat of a damaging drought is seriously affecting crop prices.
I’ll break down a few historical charts so we can better gauge where these four commodities stand. As we examine each, keep in mind that most commodities have their own point/dollar value systems, which make each market unique.
Opportunity is Brewing in Crude Oil
I was a pit trader on the NYMEX, working with crude oil and natural gas options throughout much of the 90s. And I can honestly say it was one of the craziest markets to trade. In terms of sheer volume, liquidity and size of daily moves, crude oil doesn’t disappoint.
It’s why I called it “the mother of all markets.”
But oil’s volatility back then was nothing compared to what we’re seeing today. In the pit, a good-sized intraday move consisted of a $0.30 change per barrel. Now, it’s common to see intraday swings of $5 per barrel!
And that’s opening the door for potentially massive gains. (Go here to find out how.)
You see, every $0.01 move in the crude oil market equals $10 for investors. So a $5 shift would equal $5,000. With that in mind, check out how much money smart investors could have made on oil, just in the last three months.
With the price of a barrel of oil dropping from $110 to $78 in three months’ time, playing the downtrend just right could’ve netted a cool $32,000.
Of course, these massive price swings also mean that playing the oil market can be very risky for investors who make the wrong move. Just ask traders who thought oil was going to shoot to the moon before the Great Recession hit.
Before the recession, crude oil hit an all-time high of just under $150 per barrel. And investors were seeing at least another $50 jump, trading call options for over $200 per barrel.
But when the credit crisis hit, investors liquidated their commodity positions, forcing the market to tumble to around $110 per barrel in just six months’ time.
If you were holding just a single futures contract, that drop lopped off $110,000 of equity in the market. Many commodities traders were holding hundreds of contracts, valuing their position at upwards of $100 million. Ouch!
Losses of that magnitude are exactly why I prefer to trade futures options contracts. As I mentioned before, entering options instead of just futures contracts limits your risk. That’s extremely important in any market climate.
Stay tuned for my article on Tuesday, where I’ll break down the current price action in the gold, corn and soybean markets.
Ahead of the tape,
Lee Lowell
Related Topics: Commodities, Oil and Energy
