"Risk" Back On?
Fundamentals
What a difference a week makes! Just last week it seemed that all traders wanted to do was close out their open positions in the commodity markets and move to "safe havens" such as U.S. Treasuries and the U.S. Dollar, fearing that the fallout from the European debt crisis would spread throughout the globe and trigger a major set-back to the economic recovery. However, some positive economic reports in the U.S. as well as denial that China was prepared to liquidate some of their Euro-zone bonds has given some traders renewed confidence to re-establish positions in equities and commodities. The return to "risk on" trading since last week has caused lead month July Crude Oil to rally nearly $7, after trading at 8-month lows last week. July Copper surged over 26 cents per pound , and even the beleaguered June Eurocurrency futures appear to be trying to form a short-term bottom! The upcoming long Memorial Day holiday as well as end-of-the-month position squaring might be behind some of the renewed buying, as traders close out recently established short positions. This volatile trading activity can make it very difficult for fundamental traders to hold their positions, as the sudden and sharp price swings trigger stop loss orders when current price trends change. Although it may still be too early to tell if we are headed into a "calmer" trading environment as we begin the unofficial start of summer, after the extreme volatility we have seen this past month, I suspect most traders are happy to see the month of May finally come to an end!
Trading Ideas
During the recent sell-off in Crude Oil futures, option volatility rose, as nervous traders rushed into the futures options market to buy options to help protect against extreme price moves. This buying has elevated the option premiums, as many traders now require a higher premium to accept the risk of holding short option positions. Traders who expect Crude Oil volatility to begin to fall may wish to consider taking advantage of higher option premiums by exploring potential opportunities associated with establishing a short options position. An example of such a trade would be selling out of the money puts in July Crude Oil options. With July Oil trading at 74.10 as of this writing, the July Crude 60 puts could be sold for about 0.14, or $140 per option, not including commissions. The premium received would be the maximum potential profit on the trade and would be realized if July Oil futures are trading above 60.00 at expiration on June 17th. Given the risks involved with selling naked options, traders should have an exit strategy in place should the trade move against them. An example of such a strategy would be to buy back the short option before expiration if July Crude trades below the recent low of 67.15.
Technicals
Looking at the daily continuation chart for Crude Oil futures, we notice how sharply prices have fallen this past month as traders switched their focus from potential demand increases due to improving economic conditions to a risk averse mentality which caused a major liquidation of positions in the commodities sector, with the exception of Gold. The sharp rally in Oil on Thursday has positioned the lead month July contract to test the 20-day moving average, currently near the 75.25 area. After falling into oversold levels earlier this week, the 14-day RSI has rebounded sharply, currently reading a more neutral 46.26. In order for Oil bulls to once again regain the upper hand, July Oil would need to close above resistance at the 100-day moving average, currently near the 79.30 area. Support is seen at the May 25th low of 67.15.
Mike Zarembski Senior Commodity Analyst
