by Brian Booth
Japan’s economy was not doing all that hot before the catastrophic events of the past few weeks. We are still trying to figure out where to go from here in terms of the markets, Japan, and the global economy at large.
Japanese investors were selling off assets in the aftermath of the earthquake and tsunami, and the Bank of Japan printed tens of millions of yen to create additional liquidity. The yen typically rises amid a flight to safety, but this action has driven the yen sharply lower. Traders and investors are not only taking into consideration this action, but also the fallout in terms of resource commodity demand in the region. I was surprised we didn’t see even more flight-to-quality buying in metals, but I think there is more of that to come, particularly given the added geopolitical uncertainly in the Middle East.
The big question you might be wondering is: how should I be positioned after the news in Japan and the Middle East?
I believe that if I collected a dime from every one of my colleagues each time they have heard this question in the last week, we could put a fairly significant dent in our nation’s debt!
The answer to this question will vary for each individual. Some think that once Japan’s damage is finally assessed and accurately reported, the markets will all be pressured. Others think that central bank involvement across the globe will keep markets in check and traders will use setbacks as opportunities to step in as buyers. (See Warren Buffet’s comments on Japan and trip to India).
Lastly, some traders will use this uncertain environment as a reason to sit on the sidelines and wait. (The lackluster market action on Monday, March 21, 2011 is an example of this). I believe the majority of traders are encapsulated in the latter of the three strategies.
When I turned on the television on the morning of Saturday, March 19 and saw that the news broadcasts about Japan were interrupted by breaking news of 110 tomahawk missiles being fired into Libya, I knew it was time to get into the office and start looking at levels in the crude oil, gold, silver, and the stock indexes for potential opportunities for Monday morning’s trade.
I fully expected to start the week hearing printers screaming, phones ringing off the hook, and traders scrambling to adjust or enter new positions after a big rally in crude oil, gold, and silver. I also expected to see a fairly heft dent in stocks. When I walked in and turned on my screens I was SHOCKED to see a flat overnight session. It was SO flat that the reporters on CNBC opened the show joking about the complaints they were receiving about their new set design!
In all fairness, there was weekend news of positive mergers and acquisitions in the U.S., the metals markets were already just under the chart highs, and front-month crude oil futures were one day away from expiration. Furthermore, Japan’s markets were closed for a poorly timed holiday. I believe that all of these factors kept a lid on the expected swings in Mondays’ trade.
Flat markets after the news in Libya, coupled with mixed reports in Japan, means traders were uncertain of what to do next. Experience has taught me that uncertainty in global news tends to force traders to pull out of risky investments and look for markets that carry “flight to safety” fundamentals at a reasonable price. The tricky part in this week’s trade is the fact that these “flight to safety” markets are not reasonably priced! We are just shy of record highs in many metals, the yen is flush with tens of trillions of newly printed cash and a promise from the BOJ to keep the price low for the sake of their businesses and rebuilding efforts, and the U.S. Treasury markets still have QE2 participation from the Federal Reserve.
I believe that if traders were to sit down and draw an old fashioned T-chart of the overall landscape of world markets with “pros” on the left and “cons” on the right, this chart would tip over to the right before they were half way through the process. The pro side may have just a few bullet points, including an opportunity to piggyback any central bank participation in the markets, or maybe an opportunity to sell any of these strong markets from a technical high on the daily chart, or even a chance to sell into a market on the expiration of a front month contract. Any of these moves could be the start of a major correction, but I doubt it…….let’s list the cons on the other side of the chart.
JAPAN: Nuclear threat and radiation threat, financial and structural devastation, halt of Japanese production, repatriation of Japanese investments, government intervention.
MIDDLE EAST AND NORTH AFRICA: Continued potential threats of violence in Libya, Bahrain, Yemen, Ivory Coast, Egypt.
UNITED STATES: Trillions of dollars in national debt, lack of faith in long term results of QE2, fights over how to effectively cut budgets and balance effectively.
EUROPE: Currency at two-year highs, potential rate hikes that would benefit some countries and potentially cripple others.
ENERGIES: Continued rallies in crude oil prices only help traders in long positions and those who sell and export crude oil.
I believe traders can enter the following markets with some general strategies in mind.
Metals
I recommend tradersfind a support level in May gold or silver futures that is a comfortable area to consider buying, and sell puts at that strike. I think that one of the only factors that could drop the metals exponentially would be mid-year profit taking by funds in the summer months. The objective would be to have the market stay above these levels so you can retain the full value of the option.
The margin for an option position is almost 50 percent less than an outright futures position, and it gives you exposure for a longer period of time. If the metals see technical selling from our current higher prices, traders should look to hold the short puts and at the same time sell futures for a day or swing trade when the opportunity presents itself. In essence, you would be hedging a longer term trade with this strategy. (See the gold daily chart with last year’s summer drop).
Energies
I think that the same type of strategy can be implemented for the crude oil and yes, even natural gas. All of the potential threats out of the Middle East will have traders and investors nervous about the flow of oil out of that area, and I believe the price is more in jeopardy of going higher than lower. I recommend traders find a price on the daily chart to sell puts and consider buying futures if OPEC gets involved or if the market begins to sell from technical highs on the daily chart.
In my opinion, natural gas could also be a sleeper longer-term bullish trade. Now that Japan’s nuclear energy system is in shambles, there is a faint possibility that natural gas could benefit in years to come from their need to find a suitable energy to replace nuclear power.
Stock Indexes
If crude oil and metals continue to rally, I would anticipate the stock market indexes would move lower as stocks are considered a more risky investment. Traders can look to sell out-of-the-money calls, or even buy out-of-the-money puts for what could be an extended sell-off.
When markets are volatile and choppy, short option strategies can be an approach for the right investor or trader to gain exposure to the markets. However, it’s important to keep in mind that selling options can involve unlimited risk if the trade moves against you, so it’s important to work with a professional if you are not familiar or comfortable with options strategies. I recommend watching the underlying futures markets and monitoring how the direction of the market affects the premium in the option day-to-day. Trading futures while in a short option strategy is a great way to not only hedge, but also have active participation in the short-term trade.
Please feel free to contact me if you wish to discuss any of these ideas. I would appreciate any feedback and would be happy to help you develop a more specific trading strategy tailored to your individual situation, goals and risk tolerance.
Brian Booth s a Senior Market Strategist with Lind-Waldock. He can be reached at 800-993-6601 or via email at bbooth@lind-waldock.com
Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder. Futures trading involves substantial risk of loss and is not suitable for all investors.
(c) 2011 MF Global Ltd. All rights reserved. 141 West Jackson Boulevard, Suite 1400-A, Chicago, IL 60604. www.lind-waldock.com
