by Mark Julias
We have certainly seen a lot of action in the markets over the past month! The S&P 500 has corrected more than 10 percent, the euro hit a new four-year low, and we’ve seen the worst oil spill in U.S. history, surpassing the Exxon Valdez disaster in March of 1989. For traders, these events have created a lot of volatility in all markets, and present opportunities.
I want to focus on two markets that are catching my eye in the midst of all this turmoil. Natural gas has been in a great range for trading both directions. I have a bullish bias in natural gas for a several reasons, which I will highlight.
I know a lot of you must be saying: “How can I be bullish with storage levels over 2,250 BCF, well above historical levels for this time of year?” There are some key fundamental factors than provide future upside potential.
• Seasonality – Summertime historically helps to establish lows and basing in the natural gas market. A hot summer will increase cooling demand. We are already seeing above-normal temperatures in key U.S. air conditioning areas. I think that will continue.
• Hurricane Season – June 1 marks the start of hurricane season, which can help to establish a “fear premium” in the market. The National Oceanic and Atmospheric Administration (NOAA) has predicted an active storm season, with the most potential storms since 2005.
• Global Economic Recovery – We have been seeing a global economic recovery start to take hold, and industrial demand will slowly start to come back as employment increases. The Institute for Supply Management’s (ISM) May report on manufacturing activity came in at the highest level since 2004.
• China – China raised onshore domestic natural gas prices by almost 25 percent, and it plans to increase natural gas imports by 92 percent in 2010.
• Alternative Fuels – This is more of a long shot for now, but any talk of moving away from our dependence on crude oil and into alternative fuels (such as natural gas) would be supportive.
Technical Perspective
Turning to the technical picture, we’ve seen basing and support hold in the July natural gas futures between $4.0 – $4.10 mmBTU A close above $4.376 mmBTU would be positive, and could help fuel a breakout above recent congestion highs of $4.587. That would encourage short-covering, driving the market further.
Strategies
There are numerous strategies to take advantage of market momentum, depending on your risk tolerance and account size. If you are looking to trade the futures market, I recommend buying on pullbacks. Wait for the market to come to you, and use support levels of $4.20, $4.10 and $4.00 (July contract) as places to buy, risking a close below $4.00. A close below $3.82 would be negative, and I would recommend cutting your losses at that level and getting out of your position.
I recommend traders who are bullish natural gas also consider October options. One strategy I like is the $4.75/$5.75 bull call spread, priced around $2,900, with a maximum profit potential of $10,000 (not including commission costs).
If successful, this approach would net you $8,100 after factoring in your premium of $2,900 for the option. This gives you a defined risk profile, with roughly a 3/1 risk/reward ratio.
In sum, given the still shaky economic situation we are in now, I don’t see a sky-high move for natural gas. However, we could push to $4.75, and perhaps even $5 if there is a significant storm threat.
Corn
The second market I want to discuss is corn. Even in the face of weak outside markets, corn has been holding very strong. When you look at a corn futures chart, you will see a great bottoming around $3.55 – $3.52 per bushel for the July contract (a triple bottom). Every time corn has touched these levels, it has bounced. I am very bullish corn at the current price levels. Even given the great weather we have seen so far for the planting season, I don’t think the corn market has priced any weather premium in.
As we all know, weather never stays perfect; either we get too much rain, not enough rain, or temperatures that are too hot. These are all very probable scenarios, so I believe the downside is limited, and the upside potential is good. In addition, U.S. weekly exports have been extremely strong over the last several weeks. China has been a big buyer, which is supportive of higher prices.
I would recommend capitalizing on this potential move using September corn options. Consider buying the September 380 calls for about 18 cents, or $900, not including commission costs. This gives you until August 27 (expiration) for the market to move in your favor, which I think is plenty of time to capitalize on weather-related issues that could surface. If the market moves against you, your maximum loss is your premium paid, $900, plus commission costs. The profit potential is unlimited.
Please feel free to contact me with any questions you have about these or other markets, or to develop a customized trading strategy based on your unique goals and risk-tolerance.
Mark Julias is a Senior Market Strategist with Lind-Waldock. He can be reached at 888-341-2071 or via email at mjulias@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.
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