Crude and refined products broke out higher from well entrenched trading ranges this week. The catalyst was surprise inventory draws in gas and distillates. The underlying driving forces are low US interest rates to finance trades and a weak US dollar supporting energy prices.
The US Federal Open Market Committee should have learned the consequences of a weak US dollar when the dollar vs the euro was trading at $1.60 and crude at $147. On Friday crude closed at $78.47 and the dollar at $1.4967.
Quite simply, the Fed needs to raise interest rates now, or at least begin rhetoric advising it might be a near term consideration. Without any fear at all of an imminent interest rate hike, the dollar will continue to slide, trades will be financed on the cheap, and crude has nothing stopping it from cruising to $90 by year end.
Sunday, October 18, 2009
Saturday, October 10, 2009
"Wee" Willie Keeler "I keep my eyes clear and hit 'em where they ain't."
"Wee" Willie Keeler played baseball for the New York Giants from 1892 to 1910. At 5'4" and 140 pounds, he was the smallest player ever in the major leagues. The bat he used was only 30 inches long and weighed 29 ounces. Similar size and weight as an eight year old boy's little league bat.
Amazingly he had a streak of eight seasons with 200 or more hits, matched only in later years by Pete Rose. When asked how he was able to accomplish this achievement Mr. Keeler stated, "I keep my eyes clear and hit 'em where they ain't." Successful energy option sellers strictly adhere to the same philosophy.
When selling energy options knowing where the underlying commodity price is going has value. Knowing whether the market is trending or range bound will help to gain a little extra premium on the sale. Vitally important, however, is knowing where the price is definitely not going.
Just as "Wee" Willie would scan the field to see where the opposing players were positioned, so too energy option sellers need to understand historical and seasonal price tendencies to have a high level of confidence that the sold option will expire unexercised and maximum profitability on the trade will be obtained.
Amazingly he had a streak of eight seasons with 200 or more hits, matched only in later years by Pete Rose. When asked how he was able to accomplish this achievement Mr. Keeler stated, "I keep my eyes clear and hit 'em where they ain't." Successful energy option sellers strictly adhere to the same philosophy.
When selling energy options knowing where the underlying commodity price is going has value. Knowing whether the market is trending or range bound will help to gain a little extra premium on the sale. Vitally important, however, is knowing where the price is definitely not going.
Just as "Wee" Willie would scan the field to see where the opposing players were positioned, so too energy option sellers need to understand historical and seasonal price tendencies to have a high level of confidence that the sold option will expire unexercised and maximum profitability on the trade will be obtained.
Saturday, October 3, 2009
Why Are Only 20% of Energy Commodities Traders Successful?
Most energy traders, professional and amateur, are drawn to energy commodities futures trading because they are aware of the potential for very large profits, using little capital. However, knowing the difference between potential profit and potential for profit is what separates skilled traders from the pack. This is especially true in energy commodities options trading.
Numerous studies have shown that 80% of commodities options expire worthless. While commercial traders may be offsetting these losses with gains on the physical product price movements, the vast majority of traders are unhedged and experiencing pure losses. The problem is that most traders plan a trade based solely on profit expectations and not on the probability of exiting the trade profitably.
Energy options traders are particularly vulnerable to this trap. The leveraged based margin requirements of commodities allows a trader to control a large position using relatively small premium. Traders will often receive additional incentive from their options broker reminding clients that the risk in buying a put or call is limited to the premium paid.
The problem is that the options buyer is not much different than someone trying to beat the house in Las Vegas. That is why I prefer to be the house by selling options, rather than trying to beat the house by buying options.
By selling options, I am limiting the potential for profits. I am also exposing myself to unlimited risk. However the reason this strategy works so well is that I have improved my probability of success to 80%.
Just like the Vegas casinos I have to have enough capital on hand so I can pay out the occasional losing trades. However, by carefully monitoring the market I am trading, I am able to limit these losses by exiting losing trades early and allowing the winning trades to provide a steady income stream.
Numerous studies have shown that 80% of commodities options expire worthless. While commercial traders may be offsetting these losses with gains on the physical product price movements, the vast majority of traders are unhedged and experiencing pure losses. The problem is that most traders plan a trade based solely on profit expectations and not on the probability of exiting the trade profitably.
Energy options traders are particularly vulnerable to this trap. The leveraged based margin requirements of commodities allows a trader to control a large position using relatively small premium. Traders will often receive additional incentive from their options broker reminding clients that the risk in buying a put or call is limited to the premium paid.
The problem is that the options buyer is not much different than someone trying to beat the house in Las Vegas. That is why I prefer to be the house by selling options, rather than trying to beat the house by buying options.
By selling options, I am limiting the potential for profits. I am also exposing myself to unlimited risk. However the reason this strategy works so well is that I have improved my probability of success to 80%.
Just like the Vegas casinos I have to have enough capital on hand so I can pay out the occasional losing trades. However, by carefully monitoring the market I am trading, I am able to limit these losses by exiting losing trades early and allowing the winning trades to provide a steady income stream.
Saturday, September 26, 2009
How Will the Iranian/US Tension Affect the Energy Complex?
This week crude bears were finally able to break support, taking near month crude futures out below short term trading ranges. Bulls came back into the market Friday defending the $65 support level. However, energy option put buying on HO, RBOB and CL, have dramatically increased, indicating fear of a continuing down trend. Will Iranian nuclear negotiations next month reverse these fears?
The G20 meetings this week ended on a sour note with President Obama coming forward with accusations Iran is producing enriched uranium at a previously undisclosed facility. The month of October will continue with back and forth verbal attacks, with little progress towards a resolution, unless China and France back Obama's call for stronger sanctions.
Since Iran is less than 3% of world crude production, current over supply will easily make up for any lost barrels on the market. The greater concern is a decrease in Nigerian low sulfur crude production.
Nigeria produces 13% of world low sulfur crude. Low sulfur or "sweet crude" is preferred by refiners as production costs are less than the more plentiful high sulfur crude or "sour crude". Many refiners are are not capable of cracking sour crude into petroleum products.
Nigerian sweet crude production is down one million barrels per day vs 2005 levels.
Refineries in Nigeria have been cutting production and closing facilities due to political unrest and lower demand. Any increased violence in this area will create a return to 2008 bottlenecks of world sweet crude supply resulting in increased prices for crude and petroleum products.
This is not to down play the seriousness of the tension in Iran. Should verbiage escalate into actual physical conflict, crude will be well on its way back to $100. The greater probability is for shortages of sweet crude keeping energy complex futures firm.
The G20 meetings this week ended on a sour note with President Obama coming forward with accusations Iran is producing enriched uranium at a previously undisclosed facility. The month of October will continue with back and forth verbal attacks, with little progress towards a resolution, unless China and France back Obama's call for stronger sanctions.
Since Iran is less than 3% of world crude production, current over supply will easily make up for any lost barrels on the market. The greater concern is a decrease in Nigerian low sulfur crude production.
Nigeria produces 13% of world low sulfur crude. Low sulfur or "sweet crude" is preferred by refiners as production costs are less than the more plentiful high sulfur crude or "sour crude". Many refiners are are not capable of cracking sour crude into petroleum products.
Nigerian sweet crude production is down one million barrels per day vs 2005 levels.
Refineries in Nigeria have been cutting production and closing facilities due to political unrest and lower demand. Any increased violence in this area will create a return to 2008 bottlenecks of world sweet crude supply resulting in increased prices for crude and petroleum products.
This is not to down play the seriousness of the tension in Iran. Should verbiage escalate into actual physical conflict, crude will be well on its way back to $100. The greater probability is for shortages of sweet crude keeping energy complex futures firm.
Saturday, September 19, 2009
Event Anticipative Energy Trading
Successful energy traders maintain their edge by knowing what potential market moving events will occur during a particular week. Some will anticipate outcomes placing trades prior to the events. Others will wait until the results are known.
The market moving events scheduled for this week include Wednesday's Federal Reserve meeting and Thursday's and Friday's G20 meeting in Pittsburgh.
Should the Fed or G20 surprise with news that stimulative programs, including low interest rates, are no longer necessary, look for market participants to quickly sell out of long positions, taking the energy complex down quickly.
This scenario is highly unlikely to become reality as governments want to see unemployment numbers improving before even thinking about fighting inevitalbe future inflation.
In anticipation of this week's events, crude traders will likely begin the week hoping for a pull back to $70 and then begin putting on long positions for the ride to $75.
The market moving events scheduled for this week include Wednesday's Federal Reserve meeting and Thursday's and Friday's G20 meeting in Pittsburgh.
Should the Fed or G20 surprise with news that stimulative programs, including low interest rates, are no longer necessary, look for market participants to quickly sell out of long positions, taking the energy complex down quickly.
This scenario is highly unlikely to become reality as governments want to see unemployment numbers improving before even thinking about fighting inevitalbe future inflation.
In anticipation of this week's events, crude traders will likely begin the week hoping for a pull back to $70 and then begin putting on long positions for the ride to $75.
Thursday, September 10, 2009
China's Liu Xinhua Assures Energy Markets
Liu Xinhua, Vice Chairman of China Securities Regulatory Commission, assured energy markets by saying China will seek to promote a stable and healthy market place. His comments alleviated concerns certain Chinese state owned companies would default on heavily out of the money hedge positions.
Free now from fear of counter party concerns, energy traders have been focused on US dollar weakness. The dollar is making almost daily lows vs the euro giving crude traders confidence in long positions.
With EIA inventories showing a large draw in US crude supplies last week, fewer traders will be comfortable on the short side.
Free now from fear of counter party concerns, energy traders have been focused on US dollar weakness. The dollar is making almost daily lows vs the euro giving crude traders confidence in long positions.
With EIA inventories showing a large draw in US crude supplies last week, fewer traders will be comfortable on the short side.
Tuesday, September 1, 2009
Potential China Derivative Contract Defaults
Crude is having a swift fall from yearly highs. Investors looking for the reason are pointing to China owned commodity derivative contracts, currently deeply out of the money.
It was China's buying of commodities that led crude to its yearly highs. Rumours are now circulating that several state owned China entities may walk away from hedging bets put on prior to the collapse of the world wide economy.
The total amount of derivative contracts at jeopardy is not known, but counter parties at risk advise the dollar amount is substantial.
If the rumours turn out to be true, world banking will be in for another round of losses; crude and the refined products will continue to sink.
It was China's buying of commodities that led crude to its yearly highs. Rumours are now circulating that several state owned China entities may walk away from hedging bets put on prior to the collapse of the world wide economy.
The total amount of derivative contracts at jeopardy is not known, but counter parties at risk advise the dollar amount is substantial.
If the rumours turn out to be true, world banking will be in for another round of losses; crude and the refined products will continue to sink.
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