Buying More Oil For The 1% Portfolio

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Includes: GDX, GLD, SLV, SSRI, USO
by: Individual Trader

Summary

If oil keeps plummeting, central banks will compound their easing measures.

Positions sizing in the precious metals sector kept extremely small until $1280 is surpassed with conviction.

Long term call options "Leaps" are good alternatives for fundamental investors who don't want to take extra risk but want a better return on investment.

Yesterday oil plummeted once more and we used the weakness to sell another put in United States Oil Fund (NYSEARCA:USO) (See Updated trade table below). Oil is now at seriously depressed levels. In one way falling prices and deflation are good things. It means consumers can buy more goods and services at cheaper prices. However, central banks see things differently. They believe deflation and falling prices are connected with recessions and downturns so if the slump in commodities continues, central banks will print more money at a faster rate than before. This is why the commodity trade in the long term will be profitable because if commodities like sugar and oil continue to plummet, central banks will inflate more rapidly. On the contrary if the world starts to consume more and comes out of recession quickly, more commodities will be demanded which will again lift commodity prices. Either way, the commodity trade will be a winner. The only question is timing but long term fundamental investors will wait for the commodity trade to bear fruit.

On Monday last we bought some stock in Market Vectors Gold Miners (NYSEARCA:GDX). I have written recently that I believe gold is in the process of forming a firm bottom. Why choose miners over the metal itself? Well, the reason is that we have many mining companies that are cheaper now than when gold was $400 an ounce back in 2003. Look at the chart below of Silver Standard (NASDAQ:SSRI) for confirmation

When Gold puts in its firm bottom, I expect miners to outperform Gold with distinction so this is why we chose the Gold mining ETF over Gold Trust (NYSEARCA:GLD). One word of caution about our precious metal positions. When you look at the daily chart below, it is obvious that we need to get above $1280 for the Gold market to be in full "bull mode". We will find out in the days and weeks to come if the $1140 level printed in November is indeed a firm intermediate bottom. Therefore we need to keep position sizes extremely small until we know for sure that a multi-year low has been printed.

Finally a number of followers are asking me about the "Leap strategy" call option that I talked about briefly in another article. This strategy is perfect for fundamental investors who feel they don't have enough capital and want some extra leverage without added risk. Lets look at an example. Just say you decide you want to go long silver through iShares Silver Trust (NYSEARCA:SLV). You have $5000 to put to work. The first option is to buy stock which will give you roughly 300 shares of this ETF. This ETF matches the spot price of silver at a rate of 1:1 so you would profit as the price of silver rises. Nevertheless you don't have any leverage here. Lets go through a leap call option strategy. For the same amount of $5,000 (this is our budget) you could buy the Jan17-9 Call for $800. This means that you could control 100 shares of this ETF for $800. The "delta" of the option is very important. It must be over 0.9. This ensures that the option will practically move on a 1:1 basis with the underlying stock. Therefore if you wanted to control 300 shares using leap call options, all you would have needed to invest would have been $2400 as opposed to $5000 if you had bought the stock outright. The one drawback of this strategy is that you don't collect any dividends along the way (if the underlying pays dividends) but for risk tolerance and diversification, these instruments can be extremely advantageous for the following reasons.

1. You can only lose what you invest

2. You can "exercise" your option at any time. This means you can convert you call options to shares when you want (you must have the capital in your account to buy the shares)

3. Potential return on investment is much higher than buying the stock

Updated Portfolio (12-11-2014)

Open Positions (Position size kept Ultra Small)

Underlying Strategy Result
GDXJ - 19/11/2014 Sold 25-DEC26 Naked Put Open
UNG - 20/11/2014 Sold 21-DEC26 Naked Put Open
USO - 25/11/2014 Sold Jan02-27.5 Naked Put Open
USO - 10/12/2014 Sold Jan16-22 Naked Put Open
GDX Bought Stock 09/12/2014 Open
MCD Bought Stock 25/11/2014 Open
KO Bought Stock 25/11/2014 Open
K Bought Stock 25/11/2014 Open
TBT Bought Stock 28/11/2014 Open
KOL Bought Stock 25/11/2014 Open
AXP Bought Stock 05/12/2014 Open
BDX Bought Stock 05/12/2014 Open
IBM Bought Stock 05/12/2014 Open

Closed Positions (Per One Lot Of Options Sold)

Underlying Strategy Result
GDXJ 17/11/2014 Sold 22-DEC26 Naked Put $38 Profit
MCD - 20/11/2014 Sold 94-DEC26 Naked Put $48 Profit
KO - 20/11/2014 Sold 43-DEC26 Naked Put $21 Profit

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.