September 2018 Podcast
James Cordier and Michael Gross
Michael: Hello everybody, this is Michael Gross of OptionSellers.com here for your September Podcast to go out September 21st, 2018. I'm here with James Cordier, head trader of OptionSellers.com. James, welcome to the show.
James: Good afternoon, Michael. Always glad to be here.
Michael: You know, we're already in September here and the end of summer, and everybody comes back from vacation in September. Often times, markets are waffling one way or the other over the summer and sometimes people think you get the real picture in September when everybody comes home. Did you go anywhere interesting this summer, James?
James: This summer was pretty much framed around Italy and doing a whole lot of pizza buying, some amazing pasta, and walking the beautiful streets of Florence. We did that for about a week or just a little bit more. The last half of summer did a whole lot of boating and just sightseeing in the great Midwest. We were on Lake Erie and Lake Michigan doing a lot of fishing and enjoying the water in those areas. It's just a really nice getaway. It's really peaceful, the temperatures are nice and cool, and when they say dog days of summer I think they mean not in Wisconsin or Ohio. They probably talk about south of there or east of there. It has been a really, really comfortable summer and as now we're getting back to regular season almost, if you will, it's almost like people do take a lot of time off in July, August, and September and we're certainly looking forward to being very regrouped and refreshed after a nice summer vacation. While we did a whole lot of following along with the markets and data study and counting of bags of coffee and barrels of crude oil we did do a little rest and relaxation and I think it was really good.
Michael: Well, that puts my summer to shame. I didn't go that many different places, but I did spend some time in Pennsylvania. As you know, I still have family up there. Probably my most exciting trip… I mean, it was all fun and it's always nice to see family and get out of our Florida heat for a little while, but my wife and I just took a few days and went in and spent a long weekend in the city of Pittsburgh, which is my kind of hometown. I didn't grow up right in Pittsburgh, but I grew up right outside of it, so we actually stayed in town and went around to see the sights and I think we might've jinxed Heinz field while we were there, but other than that nice summer but it's always nice to get back to work and get back to the groove in September, I think.
James: Looking forward to it, as well.
Michael: Well, speaking of September, we have no shortage of market stories this month. Probably grabbing the headlines right now is the trade war with China. I think we can possibly classify it as a trade war at this point with new tariffs going into effect, it looks like, this week and China threatening to retaliate again. So far, this hasn't really had an effect on the stock market. Where do you see this thing heading into the end of the year?
James: Michael, it's so interesting, during the podcast earlier in the summer we talked about almost two different markets. You have the U.S. economy and you basically have everyone else. Looking at the Shanghai Index, the Chinese stock market reached bear market territory months ago. It has basically been languishing in these levels, you know, 20-25% off of their all-time high. At the same time, you have the NASDAQ or the S&P making new highs or touching near those levels. It's really difficult to see how tariffs can affect the exporting countries and yet not the really monkey with the importing countries. If we were importing at 5%, 10%, 15% greater in prices, sooner or later that's going to start taking effect. It's either going to cause inflation or it's going to cause consumers, you would think, to back off just slightly. I think tariffs and raising prices is a two-edged sword. It probably affects the exporting nations first and as those more expensive items come overseas it would probably affect consumers after that. The U.S. economy, Michael, it just continues to chug along. There are one or two little breaks possibly in the housing market. I know a lot of people are starting to discuss that, but for the most part it has been onward and upward. Even with some of the largest names in the investment world, Goldman Sachs, BlackRock, and I could go on and on, really calling for get ready and have your parachute quite available as this market's about to top out and start falling. The month of September and October, if there was ever a timeframe for that to happen, we're right on the brink of that. I would think the stock market, especially in the United States, Michael, is going to probably be very interesting going into the 4th quarter and to see if these smartest minds in the United States, as far as calling the stock market, if they turn out to be right or not. They're certainly calling for time to cash in your chips and if you're not in the market at all to stay out. The next 30-60 days, I think, are going to be fascinating. I guess we'll find out soon.
Michael: Yeah, companies like Morgan Stanley I saw, they're saying a bear market already started. I don't know how they're figuring that but according to some measurement they have. The Goldman bull/bear indicator, highest levels since 1969, talks about risk of a bear market. It ended up in our newsletter this month. Did you see this interview with Ray Dalio, biggest hedge fund in the world here, last week on CNBC? Kind of some disturbing comments if you're a stock bull. Were you able to catch any of that?
James: Michael, I certainly did. Ray Dalio, of course the largest hedge fund manager in the world, not only was he calling for a stock market major correction but he was also discussing and predicting a major breakdown in the U.S. dollar, which is extremely contrarian to what's been going on recently. Of course, Michael, the United States is the only country in the world raising rates, at kind of a gradual level but nevertheless raising rates. The majority of the European Union is still doing quantitative easing. Interest rates around the world are extremely low, we've been raising them, and that's been booing the dollar. Ray Dalio, I guess we can mention by name because he put it himself out there, he was on all the networks talking about it, he is calling for 30% reduction in the value of the dollar coming up starting quite soon. That's a huge break in the value of the most important currency in the world. Talk about ringing the warning bell for people to exit positions and get to safety. Not just a small guy, the largest hedge fund manager in the world but, you know, he gets there for a reason. He is certainly waving the flag to be prepared and get ready. We'll see how it goes.
Michael: Yeah, he wasn't just saying that. He was talking about civil unrest and all this other stuff. Usually if you hear someone on the Internet and they're talking about that it's yeah whatever, but Ray Dalio said that and it turns some heads.
James: Well, civil unrest is certainly something that happens after the market has crashed or the dollar gets battered, so the economic call first and then the trickle-down effect second… I hope neither one really takes place, but certainly we're going to be prepared the best we can by being diversified and, of course, Michael, we can do well in bull and bear markets and maybe we'll find out how it goes with a bear market. It sounds like, if you listen to the most powerful people in the world, that's not that far off. We shall see.
Michael: Well, yeah and I'm sure listeners to this podcast know that's what we're talking about here is being in position to be able to still capitalize and get positive gains, maybe even very good gains, if we do get a market turn around or we do get other market stocks and what not going haywire. You still have investments that can make money in down markets regardless. So, that's something that we're constantly talking about and, as you know, especially high net-worth investors really have to look out to make sure they do have a properly diversified spread just in case something like that happens where at the 10 year anniversary of Lehman Brothers this month, or actually September, and I think a lot of people looking back at that and what type of lessons they took away from that and one of those is to be diversified and, two, to be in markets that can still make money when prices are going lower.
James: Well, Michael, it's really interesting, basically investments include being long the stock market, being long real estate, or being diversified in something that what we offer or if there's any other companies that offer what we do, we actually can prosper when markets fall, the stock market were to take a significant correction… that can be some of our very best environment. Diversification coming up over the next 90 days might be the beginning and how you get diversified and prepare yourself for lower prices in the stock market is really interesting and there's not a lot of ways to get provided for that, but that's why a lot of people love listening to us talk right now.
Michael: Sure. Again, we're not rooting for a stock market correction. We hope the market keeps going up, I certainly do; however, we have the elections coming up and that sort of thing. We hope Dalio is wrong, but if he's not, still be in position to hopefully take advantage of at least the diversified markets that we work with.
James: I was just going to finish by saying we certainly don't need a bull/bear market or a neutral market. We simply take the fundamentals of the commodities and position it accordingly. Do I hope that Ray Dalio is incorrect? Absolutely. I'm quite sure everyone else is pretty much in that same side.
Michael: Speaking of being in markets that can profit when prices are moving lower, this month, obviously the title of this month's podcast is Two Investments to Make This Month that are Uncorrelated to Stocks. We are going to talk about two of those markets this month that you can take a look at right now and potentially profit from regardless of what happens in stocks or the upcoming elections or the Chinese trade war. James, let's move into our first market. This is you talk about an uncorrelated market that really marches to its own beat. We're going to talk about the cocoa market this month. Sometimes these backwater markets that are off the front page are where some of the best most lucrative opportunities can be when you're an option seller. Right now we have the big story in cocoa is the media has been hyping the record grind in Europe for the second year in a row. They're talking about demand amping up and yet from these fundamentals we're looking at it looks like the reality may be just the opposite. It looks like some quite bearish fundamentals. Do you want to talk about what you're seeing there right now?
James: Michael, it is interesting. Cocoa probably couldn't be any more uncorrelated to stocks or any other investment, for that matter. What's happening right now with chocolate is we've had some pretty decent demand over the last year or two in places like Asia, of course the demand is always large here in the United States, as well as other European nations. What's coming up though is we've had some very decent grinds recently. That was probably replacing needs that were already filled in places like Asia. We now have some of the largest record crops produced over the last 2 years and that is starting to more than overtake the strong demand that we've had recently. We're actually going to have carryout levels; in other words, global supplies have reached the third highest level on record coming up in the 2018-2019 season. In addition to that, that's the supply side and what's going on right now in Asia, especially in China, people purchase luxury goods, like cocoa, believe it or not with their checkbook. As things are going well, people eat more things that they don't necessarily need, cocoa being one of them, coffee being another, sugar being another. As the stock market languishes in bear market territory, there's probably quite a lag effect for demand showing up or lack thereof because of a very weak stock market and a weaker economy in China. These numbers that have shown great demand for cocoa, we see that probably lagging quite a bit. Now that we've found a weakness in China, these figures are going to come out in the 1st quarter of 2019, the 2nd quarter of 2019. Smaller grinds, smaller demand, and yet we're going to have the 3rd largest supply ever in history really setting up for a bearish move starting probably in the next 30-60 days. We would look to position ourselves for a seasonal decline in cocoa as the largest harvest in history starts taking place here in September and October. Coupled with probably smaller demand, the seasonality of what might happen in cocoa in the next 30-60 days is lining up, Michael, I think, extremely well.
Michael: You covered a lot of ground there, James. I just want to back up. You talked about the big supply, you talked about decreasing luxury demand out of China in I think that's what they call luxury goods, chocolate, but the big story there and something you brought up right there at the end are listeners they want to get their arm around is that seasonal tendency, which is cocoa prices. If you get our newsletter, the Option Seller Newsletter this month for October, we have a feature in cocoa, there's a seasonal chart in there. You'll see a very particular seasonal tendency for prices to start trading substantially lower from September on, right into the year. You're saying it's because of this West African harvest, primarily Ivory Coast, Ghana, those types of countries, that are going into their main crop right now. Like other agricultural markets, when that supply comes in supplies are highest and prices tend to go to their lowest, and that has tended to happen in cocoa over the years. We're right before that time, I think we're starting harvest this month, so we're starting back into that time of year again and you're thinking that seasonal is likely to kick in again this year?
James: Michael, as you know, so many commodities like corn or wheat or soybeans, they're just grown in so many different regions of the world, different hemispheres. The harvest in many commodities is almost an ongoing event at this point. The big exception with that is cocoa. It has a very pronounced seasonal decline, starting in September and October, and that's because some 80% of world production comes from a very small region, and that being Western Africa. Harvest does, for the most part, take place all at the same time. Of all the seasonals that we follow, cocoa production ramps up in a big way starting the 4th quarter of each year. It's basically the same region, that is Western Africa, and they're supposed to have a record crop size of production this year. So, very pronounced seasonal move likely starting as we speak. When you have record production and you have a timing of potential smaller demand, it could certainly be a seasonal move that we're expecting to fulfill again this year, definitely.
Michael: So, we're talking about a seasonal tendency that has fundamentals that appear to be backing that seasonal tendency. For a good option sale, those ducks appear to be in a row. Now, for our listeners that were listening to us back in the spring, we talked about cocoa back then and the thing was rallying at that point. What you were saying at that time is, "Look, a lot of this is a media event. We were looking at the supplies and the weather and saying it can't go much higher, it's likely going to come down." It has come down substantially since that point, since the highs last spring. In looking at that chart, do you feel it still has room to move substantially lower or you think we'll go steady to lower from here? I know we're not trying to guess what prices is necessarily going to do, but if you're looking at that or somebody looking at that chart may say, "Well, it's already come down quite a bit", but you're thinking this could go down a little further or a lot further?
James: Well, on a percentage basis, it's not going to probably fall more than 10 or 15% likely. We did see extremely high levels in spring of 2018. It reached into the $2,800 a ton, practically $2,900 a ton. What's so interesting, Michael, about option selling is someone might look at that chart and say, "I wish I could've sold it at that peak around $2,800". Here's the beauty: the cocoa market, which has had a decent rally from some pretty sold off levels over the last 30 days, we can sell call strikes near those extreme highs that we've seen. So, though you weren't able to sell cocoa at $2,800 or you may have not taken advantage of it, there are strikes on the call side at $2,600, $2,700, $2,800 a ton that provide a really good amount of premium. If cocoa prices are going to probably likely fall into the low $2,000-$2,100 a ton, those strikes are extremely far out-of-the-money and we do see seasonal decline starting in the next 30 days or so. On a percentage basis do I see it falling a lot more? Not necessarily, but going up to $2,700 or $2,800 a ton, which were absolutely extreme levels earlier this year, we think we're in a very safe place selling at those levels over the next couple days.
Michael: So what you're saying is we're looking at the highs back in spring, people can sell call strikes there. Prices don't necessarily have to fall. As long as they don't go back to those highs here right into the heart of harvest, those are likely going to be profitable trades, correct?
James: Michael, that's exactly how we see it. The fundamentals are extremely heavy right now. The rationale for that rally was just an absolute head-scratcher. Supply and demand then dictated to be at that level. If you look at levels in cocoa 6 months ago, 9 months ago, 12 months ago, we're basically trading back at fair value around $2,200. We saw a lot of levels in 2017 that was trading around $1,900, $1,950 a ton. We could fall to that level and, if we do, being short calls at the $2,800, $2,700 level look to be a pretty nice position with quite a bit of room to spare. We'll find out.
Michael: Okay. Obviously, you and I are looking at a number of different strikes and different type of strategies we can do here for managed portfolios, but for the guy listening to this at home and he's saying, "Yeah, I might want to try this", you're talking about selling the $2,700 strike, what type of premium and what month? What's he going to get for selling this? What type of return on investment can he expect?
James: Michael, everyone probably who does this on their own selects a different amount of time and they're trying to select a different amount of premium. I'm looking at possibly the May contract of the $2,700 call, we can look at the July $2,800, you can go to September and sell the $2,900 call. These premiums that you're collecting are in the $500, $600, $700 range. Of course, these positions don't need to be held until expiration. I know we rarely do that. Collecting 80% or 90% of that premium works quite well. Right now, margin for selling about a $600 options is right around $1,000. So, you can kind of base your position sale and how much margin is required by using that rule of thumb. Right now, an $800 option, if you go into like July or September, the margin on that option is about $1,100. Anyone who is familiar with option selling knows that that amount of margin to hold that type of premium is actually quite comfortable and really doesn't cost a fortune to hold these positions. In my opinion, the ROI on it, if you will, could be quite good.
Michael: So the guy selling at home, he sells the May or the July option… if he theoretically he holds it until expiration and it expires worthless, obviously nothing says it has to do that, he can lose money, no guarantees there of course, but if he holds it until expiration and it expires worthless he's going to make about 60-70% return on equity. What you're saying is he doesn't have to do that though, he can possibly get out of that option 2, 3, 4 months early and still maybe make 50%, 55%, 58% on that option. Is that the type of percentages he's looking at there?
James: Well, doing that math, that's exactly what it would be. Michael, if you sell an option for $600 or $700 and it has 80, 90, 120 days remaining on it, if you sold the option fairly well and, like you said, no guarantees here or anywhere else, if you sold it fairly well and the market behaves similarly to the fashion you were hoping for that option will probably have lost 80% or 90% of its value already. Staying into the market until the very last day trying to collect the very last dollar, I'm sure some option sellers do that, if there's a couple months remaining or 90 days remaining on a position and you've already collected $600 out of $700, to me that's quite the buyback candidate. Close out the position, close out your risk, and get involved with the next opportunity. I know that's what we like to do. It doesn't always work out like that, certainly, there's no guarantee like you mentioned, but that's what we do… take 80% or 90% of the potential gain and walk away and close out your position and put your money to work on the next position.
Michael: For those of you listening, if you'd like to read James' full research and trade report on the cocoa market along with his recommendations, you'll want to make sure you get this month's October newsletter. That will be in your e-mail and physical mailbox somewhere around October 1st. The e-mail will come out, I'll check my calendar here, I believe it's the 28th of September and then you should see it in your physical mailbox somewhere around the 1st or 2nd of October. James, let's move into our 2nd market here… that is the crude oil market. We're talking about markets that are uncorrelated to stocks. You could make the argument crude has some correlation to stocks at times; however, what we're talking about is the trade itself having no correlation to stocks and I think that's where we're going in here. Let's talk a little bit about crude. You were once again on TD Ameritrade this month addressing their 11 million strong client base on the crude oil market. I've got some letters and people asking are we now in some type of partnership with TD Ameritrade or are we getting bought by TD Ameritrade. That's obviously not true. They've asked us to provide our commentary and we've agreed to do that. We're not in business with TD Ameritrade by any means.
James: No. Our only real interest with TD Ameritrade is our love affair with Lionel Richie. That's about the only thing that I can think of. I had the opportunity of seeing him in concert last year and just what a great performer. But no, the energy market is certainly near and dear to many people's hearts. You're right, Michael, watching energy over the last 10 years or so it would fall with the stock market, it would rally with the stock market, and it has kind of divorced itself from the recently. What's coming up starting in late September and early October and after shoulder season, and that is the seasonality of where demand in the United States starts to taper off and often prices start slipping along with it.
Michael: Now, crude has been pushing up lately, back up near the $70 level. I know you've been saying all summer, "Well, it's likely not going to go above $75 to sell calls and it has bounced up and down but it hasn't gone above $75." Those calls are looking pretty good right now but you're looking at a strategy saying this should continue, those call options in crude should likely continue to be a cash cow at least through the end of the year. Are you looking at supply numbers right now, are we looking at U.S. supply, looking at world supply, or are we just looking at the seasonal?
James: You know, Michael, similar to what we were talking about in cocoa, long-term fundamentals are kind of lining up with the seasonality. This past week it was announced that global productions were past 100 million barrels for the first time ever. The United States is now producing 11 million barrels per day, as well. Supply here in the United States is back up to its 5 year average, gasoline stocks in the United States are at all-time record highs for the month of September, so there are headlines. There's headlines like Iranian oil is a no-no to be purchasing that starting in November, Venezuela is really having difficulty producing oil. If you peel the onion back just a little bit, these barrels of oil that came out of Iran that supposedly you can't purchase, I bet those get purchased. I bet someone decides the fact that there's millions of barrels of oil sitting on the seas that have the Iranian stamp on them and I wouldn't be surprised to see countries like China or possibly other ones purchase that oil. They probably get it at a discount. These countries they don't produce wine, they don't produce technology, they pump oil. When you see that there's a slight problem in Venezuela or Libya or Iran, those are usually short-term. When those production figures come back online, the supply crunch and all the headlines are going to go away, in my opinion, and the seasonality we call shoulder season that's when demand really falls off in the United States. That's what we're talking about today is the seasonality of markets that start to drift lower in October and come December they're nowhere near the highs that they were when all the headlines were screaming about supply crunch. The seasonality called shoulder season is after driving season, which ends September, it's before heating season, which really starts in January, and those 3 months in there U.S. demand, the largest consumer of oil in the world, really falls off and that's the seasonality that's starting here in the next week or two.
Michael: Now, you are going kind of contrarian here and I just want to justify that for the readers because oil today, near month oil, up above $71 a barrel for October. That's near the highs for the year. Is that what's driving it now, the Iranian situation? Is there other headlines driving crude in the short-term that's pushing us to those highs right now?
James: There's a couple of headlines that just came out. Saudi Arabia this past week was quoted saying, "We wouldn't mind oil surpassing $80 a barrel." Well, when you think of it, if you're an oil producer and you were pumping oil for $40 and someone put a microphone in front of you and said, "Would you mind oil being over $80", the answer would probably be no. If you are a soybean farmer and you produce soybeans for about $8 a bushel and someone said, "Would you mind soybeans being over $12 a bushel", you'd probably say no that was fine. That's what really spurred a bit of a rally this past week in the oil market. At the end of the day, we have all-time record production globally just surpassing 100 million barrels a day. We probably have, as a matter of fact, OPEC came out this past week also saying "Look out in 2019 and beyond" as we're seeing for the first time global demand finally slowing. So, at a time when you have record production and slowing demand, that sells $80 oil for Brent and $70 oil for WTI looking pretty frothy. The fact that you produce oil in the United States for $40-$45 a barrel, there's certainly some leeway for it to come down, especially if we have a shoulder season that kicks in here in the next 90 days.
Michael: Now, as an option seller there is a hidden and potentially lucrative benefit to being a contrarian. Your view is most likely contrarian to most, at least to the media right now, but media has an agenda, which anybody who follows the media in current times knows that most media has some type of agenda, all types but even financial media tends to have, at least in my opinion, a bullish bias towards markets that tends to get people more whipped up and want to watch more. It also brings the public into the market, which means speculation and people buying options. That can really drive up those premiums and I know that's something and another factor that you're taking into consideration right now shopping for these call premiums right now.
James: It is and boy do people like discussing bull markets and runaway oil prices. Just like hurricane season with the weather channel, the financial markets love talking about higher oil prices. It seems to be near and dear to everyone's heart, trying to figure out where it's going to go or how high it might be. It really has whipped up call option buyers going out 6 months and 12 months. Oil trading in the 60's for next year's contracts, we have call premiums at $90 a barrel and $95 a barrel and recently on this little rally we have $100 call options being bid for $500, $600, and $700 each. Boy, does that sound frothy to me.
Michael: So, as far as the public driving up those premiums, you're looking at strikes up around $100 level. What month and how far are they going out in time to get those strikes?
James: Michael, similar to what we talked about in cocoa, if you want to be shorter term and you want to be safe 3 months to 6 months out, you'd be selling the $90 calls. If you're willing to go out another 2 or 3 months past that it's the $95 calls. You're looking out about 1 year to be trading a $100 call option, but keep in mind also that contract is not trading at $71, it's trading in the mid $60's and part of the reason why is because some of the fundamentals we talked about look a little bit bearish as you go a year out. As a matter of fact, the people who and the powers that be who price those futures contracts they have them some $7 below the stock price expecting that decline, as well. So, not only do you have fundamentals saying, "We're not, we're at $71 a year out" but also you have the futures market trading that way. They're calling for a $7 decline in the price of oil over the next 6-12 months based on futures prices and. At the same time, you have investors buying $100 calls even with that information really being known to everyone else, so the strike prices are 45%, 50%, 55% out-of-the-money in some cases depending on what strike you're looking at. It is a contrarian view. Everyone is extremely bullish crude oil right now, it seems to go up on just about any type of jitter, and that's why seasonality of this year could come into play in quite a good way.
Michael: So, the high net-worth investor out there, he's looking for a way to get diversified and he hasn't sold options yet. I'm just going to clarify for you a little bit. James is talking about a distant contract and the price of oil in that contract is about $65 a barrel. What he's doing is selling a call option at the $100 strike. You didn't talk premiums, James, but I'm assuming you're somewhere around the $600, $700, $800 range. Would you say that's fair?
James: That's correct, yes.
Michael: Okay. So, you're selling that $100 strike. As long as oil prices don't go to $100, it can do anything else as long as it doesn't go to $100, by expiration that option will expire worthless and you'll keep that $600, $700, $800. I'm guessing it's probably going to be 50%-60% return on the margin you put up, but in looking at the chart, James, yeah maybe the Saudis or OPEC can push to $75 but, boy, to get it to $100 you're going to need some type of shock I would think.
James: Well, not only that, but the price structure has these extra barrels and smaller demand starting to price in. I just don't see also how the current administration allows oil exports to continue if the prices started driving up towards those levels. Talk about a proactive person in the White House right now. Can you imagine $100 oil and what that would be doing to Pennsylvania Avenue? I just don't see that happening but that's what makes it a market. There's a bull and a bear. The people that are buying these $100 calls think it's going to that level and we're taking the contrarian view that as these extra barrels come online and as demand slows somewhat, I don't think we'll be trading at the century mark for a barrel of oil, but we'll have to wait and see.
Michael: Well, two solid markets this month. Those are two you can look at uncorrelated equities. If you want to take a step back from equities and out of the whole election cycle and everything else going on right now, these are two you can look at and see if you can generate some premium this month.
James: Certainly, Michael. My pleasure.
Michael: For all of you listening, have a great October and we will talk with you again in 30 days.