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High Net Worth Investor Series

OptiOn Selling

Commodities Options for the Stock Option Seller
Commodities Options for the Stock Option Seller

Commodities Options for the Stock Option Seller

On SteroidS

By: James Cordier, Michael Gross, Portfolio Managers, Liberty Trading Group/OptionSellers.com Copyright 2010 Liberty Trading Group

Cordier, Michael Gross, Portfolio Managers, Liberty Trading Group/OptionSellers.com Copyright 2010 Liberty Trading Group
Cordier, Michael Gross, Portfolio Managers, Liberty Trading Group/OptionSellers.com Copyright 2010 Liberty Trading Group
Cordier, Michael Gross, Portfolio Managers, Liberty Trading Group/OptionSellers.com Copyright 2010 Liberty Trading Group

Table of Contents

How I got Started Selling Commodities Options

1

Selling Commodities Options-That big of a step?

2

The 5 Key Differences between Stock and Futures Options

2

Selling a Commodity Option – Example

3

Tips for New Commodity Option Sellers

4

The Short Cut to Getting Started

5

By: James Cordier, Portfolio Manager How I got Started Selling Commodities Options I discovered commodities

By: James Cordier, Portfolio Manager

How I got Started Selling Commodities Options

I discovered commodities when I was 14 years old. I had a coin collection and kept it meticulously organized by date, type, et. One day I bought a set of silver coins and kept them together as a set. While my brother was playing baseball, I was following the price of silver in the Wall Street Journal. A few months later, I noticed that silver prices had risen to over $6.00 an ounce. It was about $4.00 an ounce when I bought the coins. I took them down to my local metals dealer and asked what he would offer for my coin set. To my surprise, he offered me $60 for the set, a 120% profit from the $25 I had paid for it. As much as I liked my coin set, I took the money. I could buy more coins. He bought them for the silver value alone. When I got home I thought “That was pretty neat.” I was hooked.

10 years later, I became a commodities broker. One of my first duties was helping my clients to buy options. It took me 5 years to figure out that buying options is a tough way to make money. I could study every tiny detail about soybeans, coffee, oil or gold, get the market direction right and we would still lose money because we bought an option.

And then I read a statistic that 80% of options expire worthless. So I started my study of option selling. I talked a few of my clients into giving the strategy a try. It worked – extremely well. There was only one problem. These guys were gamblers. They were futures traders. They were in it for the thrill. Making 20-30-even 40% a year was not enough for them. They wanted the action. Selling options was a little slow for their tastes. What I found they would do is take their option selling profits and use them to make big bets on fast moving futures contracts. Some actually caught a few big moves and cleaned up. Most of them didn’t. I still remember one client saying to me “Well, we lost another one. I guess we’ll have to sell some more of those options to raise enough cash to try it again.”

Gamblers vs Investors

That’s when I realized the difference between investors and gamblers. And so, in 1999, I started my own firm, specializing exclusively in selling options. My firm was for investors. At that time, many investors were not ready to accept this “new” investment strategy they had never heard of (despite the fact that funds had been quietly using it for years.) We

started slow, wrote a few articles. And clients started coming. And people started to get it. And we started to get some buzz. Pretty soon McGraw Hill came knocking. They thought we had a pretty good concept and wanted us to write a book. So we did. Then CNBC, The Wall Street Journal and Barrons started calling. And we have never looked back.

I did not write this to brag but to tell you the story of how

I discovered selling commodities options. I don’t think

selling options is the perfect strategy or the guaranteed path to wealth. Every investment has it’s drawbacks and risks. However, in my 25+ years of helping clients invest their money, I have never found anything more consistent.

their money, I have never found anything more consistent. I started my career nearly 25 years

I started my career nearly 25 years ago as a retail futures broker working with individual investors. Way too often, we would get the direction of the market right and still lose money because we were buying options.

Anything and everything you read in this report or any of our newsletters, website, or portfolio literature is based on real life, in the trenches, hard won experience. You are not going to find pages of long winded, ivory tower “theories” or pages of useless greek hieroglyphics. It is my opinion that 90% of everything written on trading options is either useless to the individual investor or outright garbage. Selling options successfully only requires a little elbow grease and a lot of common sense.

This booklet was written for stock option sellers to introduce them to the concept of selling commodities options. However, even if you’ve never written any kind of option before, you should find it to be a helpful primer on collecting big premiums without having to pick market direction ever again.

Past performance is not necessarily indicative of future results. Futures and options trading involves risk of loss. Only risk capital should be used.

www.OptionSellers.com

Copyright © Liberty Trading Group 2010

800-346-1949

Selling Commodities Options – Is it really that big of step?

If you are currently writing options on equities, I don’t need to sell you on the concept. You understand that by selling options, you no longer have to predict which way the market is going to move. Your primary concern is only where prices are not going to go. You know these odds. You know it works.

Expanding your option selling enterprise into commodities is not a large leap from where you are. After all, you’ve already gone down the rabbit hole. You’ve already embraced an alternative strategy. You’ve seen the light that there is more to investing than “buying low and selling high” regardless of what the TV, the newspaper or your financial advisor tells you. You get it, which means you’re already ahead of 95% of all individual investors.

You can look at selling commodities options as simply an extension of what you are already doing. Sure, there are some key differences which you will learn in this report. However, the core concept remains the same. The draw is, the potential for much larger rewards implementing a strategy you already know.

larger rewards implementing a strategy you already know. If you’re already selling equity options, expanding into

If you’re already selling equity options, expanding into commodities can be a natural transition.

Option selling on futures is not for everybody. It requires the willingness to embrace an “outside the box” type of mentality. It requires a moderate acceptance of risk. It takes a little work – a little study. If you are looking for “action” or “something to do with your spare time,” this is not for you. If you are a serious investor considering a serious investment, you’re in the right place.

One key distinction will be your purpose for selling options. Of course, the ultimate purpose is to make money. However, in equities, the designed purpose is often to collect extra income on a stock you already own, or as a means of collecting income until a stock hits a level at which you wish to purchase it. In commodities, you will have no intention, or need to own the underlying (futures contract). Using the concepts we suggest, there is no need to get involved with taking delivery, getting assigned, getting exercised, et. You will be selling options so far out of the money that this will not be a concern. There is no need to make it messy. This is pure, simple premium collection. The question is, why would you want to? That question is answered in the next segment.

5 Key Differences between Stock

and Futures Options

(Why expanding into commodities options could be well worth your while)

There are substantial differences between writing stock options and writing futures options. However, what it generally boils down to is leverage. Futures options offer more leverage and therefore can offer greater risk, but also greater opportunity for profit. In selling equity options, one does not have to guess short term market direction to profit. The same remains true in futures, with a few key differences.

1 Lower Margins (Higher ROI): A key factor that attracts many stock option traders to futures. Margins posted to hold short stock options can be 10 to 20 times the premium collected for the option. With the SPAN margin system used in futures, options can be sold with out of pocket margin requirements* for as little as 1 to 1 ½ times premium collected. For instance, you might sell an option for $600 and post an out of pocket margin of only $700.

2 Attractive premiums can be collected for deep out of the money strikes. Unlike equities, where to collect any worthwhile premium, options must be sold 1-3 strike prices out of the money, futures options can often be sold at strike prices far out of the money where adverse short term market moves will not adversely affect the position, yet time value erosion may be allowed to work less impeded by short term volatility.

3 Liquidity. Many equity option traders complain of poor liquidity hampering their efforts to enter or liquidate positions. While some futures contracts have higher open interest than others, most of the major contracts like Financials, Sugar, Grains, Gold, Natural Gas, Crude Oil, etc. have substantial volume and open interest offering several thousand open contracts per strike price.

Past performance is not necessarily indicative of future results. Futures and options trading involves risk of loss. Only risk capital should be used.

www.OptionSellers.com

Copyright © Liberty Trading Group 2010

800-346-1949

4 Diversification – In the current state of financial markets, many high net worth investors are seeking precious diversification away from equities. By expanding into commodities options, you not only gain an investment that is 100% uncorrolated to equities, your option positions can also be uncorrelated to each other. In stocks, most of the time, your individual stock (option) will be largely at the mercy of the index as a whole. If Microsoft is falling, chances are, your Exxon and Coca Cola are falling too. In commodities, the price of Natural Gas has little to do with the price of Wheat or Silver. This can be a major benefit in curtailing risk.

5 Fundamental Bias – When selling a stock option, the price of that stock is depending on many, many factors - not the least of which is corporate earnings, comments by CEO/Board, legal actions, Fed Decisions, or direction of the overall index. Soybeans however, can’t “cook their books.” Silver can’t be declared “too big to fail.”

books.” Silver can’t be declared “too big to fail.” Knowing the fundamentals of a commodity, such

Knowing the fundamentals of a commodity, such as crop sizes and demand cycles, can be of great value when selling commodities options.

In commodities, it is most often old fashioned supply and demand fundamentals that ultimately dictates price. Knowing these fundamentals can give you an advantage in deciding what options to sell.

Commodities Option Selling – An Example

The following example illustrates the concept of selling a futures option. This is for example purposes only and assumes the seller is neutral to bearish crude oil prices.

assumes the seller is neutral to bearish crude oil prices. Selling a Call Option in September

Selling a Call Option in September Crude Oil

Date: April 20, 2010

Scenario: An investor is neutral to bearish on crude oil prices and wishes to collect premium above the market.

Trade: Sells September Crude Oil 130 call

Premium Collected: $700

Margin Requirement: $1400

Expiration Date: August 17, 2010

Risk: The risk to the call seller is that crude prices move substantially higher. If the option goes in the money, it could be worth more than he sold it for at expiration at which point, he would have to buy it back at a loss. He could also choose to buy it back at any time prior to expiration, even if it was not in the money. This can be an excellent risk management strategy.

Summary: If September Crude Oil Futures are ANYWHERE below $130 per barrel at option expiration, the option expires worthless and the investor keeps the full premium collected as profit. Notice that the call can be sold at a level nearly 50% out of the money (Crude oil prices would have to increase by 50% prior to option expiration to go in the money.) The option could also be bought back at any time prior to expiration at a varying level of profit or loss. Bullish oil traders could use the same strategy by selling put options far beneath the market. Note the margin requirement vs. premium collected is nearly a 50% return on capital if the option expires worthless.

Past performance is not necessarily indicative of future results. Futures and options trading involves risk of loss. Only risk capital should be used.

www.OptionSellers.com

Copyright © Liberty Trading Group 2010

800-346-1949

Tips for New Commodity Option Sellers

Many investors have achieved attractive returns with a properly managed option selling approach in equities. However, equity traders who have been successful in selling options can consider adding futures options to their portfolio mix both for diversification and return aspects. Gaining higher leverage can carry increased risk in some situations, but can also produce substantially higher returns in an option portfolio. At the same time, as mentioned above commodities tend to move independently – not only from equities, but from each other. This can be an attractive alternative to those seeking investments non-correlated to the equities markets. However, to futures neophytes considering such an approach, I make the following “quick tip” recommendations:

Quick Tips

1. Be sufficiently capitalized – Futures margins can vary depending on market movement. Be sure to keep a sufficient cushion of cash in your account to absorb potential margin increases. Like many alternative investments, option selling is a strategy that requires sufficient equity to take advantage of the high probabilities. We recommend at least $100,000 to start for our clients.

2. Stay diversified – this universal investment principal still applies in option selling. Keeping your positions spread out over a variety of uncorrelated markets can substantially dilute your risk

3. Sell Deep out of the Money Strikes – As we covered in a past issue, this can not only improve your win ratio, it insures a good nights sleep

4. Know your Fundamentals – Commodities are not stocks. P/E ratios, management decisions, insider buying are all out the window. Prices can be affected by weather in Iowa, a strike in Peru or a pipeline disruption in Nigeria. Get to know what moves the price of each commodity or work with somebody that knows.

This report is meant to be an introduction to this investment strategy of which many are not yet familiar. To learn all about option selling on commodities and discover a simple, effective strategy for doing so, we recommend our book, The Complete Guide to Option Selling (McGraw Hill 2009) now in it’s updated second edition. In addition to positioning properly, how you manage aspects such as risk and margin will ultimately have the greatest impact on your overall success. The biggest mistake I see neophytes making is the tendency to try to manage their commodities option portfolio like a stock option portfolio. Learn the differences and your commodities option writing account can not only be an excellent, non-correlated diversifier for your equities, but a stand alone investment in it’s own right.

How do you start selling options in Commodities?

Commodities options are traded across the globe. For our purposes, we will focus on those traded at the major US exchanges in Chicago and New York. To sell commodities options, you must use a licensed futures broker. Experience and competence of futures brokers varies widely and it is best you if seek out one with broad experience in selling options. Very experienced option selling professionals can even manage your account for you if you so choose.

Past performance is not necessarily indicative of future results. Futures and options trading involves risk of loss. Only risk capital should be used.

www.OptionSellers.com

Copyright © Liberty Trading Group 2010

800-346-1949

The Short Cut to Getting Started

Work with the Option Selling Specialists

Learning the fundamentals of commodities, adjusting to the margin requirements, leverage and individual “point” values of each commodity can take time and commitment. It can also pay off for those willing to take the time. However, for those wishing to enjoy the benefits of selling commodity options but lacking the time or expertise to get started, there is a short cut. Liberty Trading Group, North America’s Option Selling specialist, has been working with high-net worth investors for over a decade in the option selling field. With $75 million currently under management, Liberty Trading offers fully managed commodity option selling portfolios to investor-clients across 6 continents. No experience is necessary to get started.

Recommended First Steps

For more information on option selling portfolios with Liberty Trading Group, you can request a Free Option Seller Information Packet complete with examples and audio CD at www.OptionSellers.com or call 800-346-1949 (813-472-5760 Internationally).

or call 800-346-1949 (813-472-5760 Internationally). Request a free trial subscri p tion to Liberty Trading’s

Request a free trial subscription to Liberty Trading’s client newsletter The Option Seller by visiting www.OptionSellers.com

(Note: Liberty Trading Group accepts only a limited amount of high net worth investor clients each month. Information packets and sample newsletters are reserved for investors with over a $500K net worth.)

Author Bios

James Cordier is the founder of Liberty Trading Group/OptionSellers.com, an investment firm specializing exclusively in selling commodities options. James’ market comments are published by several international financial publications and news services including The Wall Street Journal, Reuters World News, Forbes, Bloomberg Television News and CNBC. Michael Gross is an analyst with Liberty Trading Group/OptionSellers.com. His work has been featured by Barrons, Yahoo Finance and Optionetics.com. Mr. Cordier’s and Mr. Gross’ book, The Complete Guide to Option Selling 2 nd Edition (McGraw-Hill 2009) is available at bookstores and online retailers now.

2009) is available at bookstores and online retailers now. Order now at Amazon.com Liberty Trading Group

Order now at Amazon.com

Liberty Trading Group 401 East Jackson Street Suite 2340 Tampa, FL 33602

800-346-1949

813-472-5760 (International) www.OptionSellers.com

** Price Chart Courtesy of CQG, Inc.

***The information in this article has been carefully compiled from sources believed to be reliable, but it’s accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss, and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account size. Before trading, one should be aware that with the potential for profits, there is also potential for losses, which may be very large. All opinions expressed are current opinions and are subject to change without notice.

Liberty Trading Group

401 East Jackson Street Suite 2340 Tampa, FL 33602

800-346-1949

813-472-5760 (International) www.OptionSellers.com