Commodities: Worlds of Opportunities, the Limited-Risk Way

 | Jan 26, 2012 | 12:30 PM EST
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This commentary originally appeared at 11:07 a.m. EST on Options Profits -- the options trader's source for daily trading strategies and actionable trade ideas. Click here to learn more.

Even if you don't trade commodities directly, you have to be aware of what is happening in those markets. In fact, like the armed service mantra, commodities traders do more by the open of the NYSE than most do all day.

Think about it: Every morning you check the stock futures prices, crude, interest rates, gold and the dollar to set up for the day. They will all directly impact the stock market opening and the rest of your trading day.

Up and Down Price Moves

Almost every equity play has an underlying commodity component that drives it. The stocks that you invest in are heavily influenced by the finite global resources and financial commodities as much as anything else. It ALL comes back to commodities!

The retail interest and trading volume in commodities has grown exponentially in the past few years. Greater access has made these dynamic markets available to anyone and everyone. Unfortunately, unfamiliarity and outdated market myths have prevented many from taking advantage of this underappreciated asset class.

Risk Control

A popular misconception is that commodities are dangerous. The key to any market is risk control. Technology has changed from my floor trading days to where the playing field has been leveled for equal access to the almost endless opportunities. And, as far as risk control, most of the commodities markets are 24 hours, so your exit orders will be executed electronically even if you're not in front of the screen.

Discipline is the key to success, regardless of investment vehicle. The classic "plan your trade, trade your plan" is critical for proper money management. The efficiency in the futures markets is great compared to other markets that have limited hours and are prone to gaps up or down session to session as money moves around the globe.

You already are in the commodities markets with the goods you consume and the food you eat. The interest rate on your mortgage, the dollar exchange for vacation, and most visibly the gas you put in your car all fluctuate on a regular basis. Most investors have added energy companies, mining stocks or exchange-traded funds for resource positioning.

Pure Play

Individual commodity prices are governed by supply and demand. That equilibrium is determined by the price discovery process to determine true value for tangible items. Shortage and surplus are opposing forces that can be used for profit. A stock is just a piece of paper traded for what people think it is worth and has no intrinsic value.

Stocks are influenced by corporate earnings, analysts opinions and accounting guidance. Too many influences in equities have nothing to do with the financial reality of today. Commodities on the other hand have always had and always will have real value as resources that cannot be done without.

Leverage on Leverage

One interesting attribute in the futures market is the power of leverage. For outright buying or selling commodities, contracts are controlled by a good-faith deposit, usually 5%-10% of the total cash value. You are able to control 1,000 barrels of crude oil (worth $99,000), for $7,500; or 100 ounces of gold ($170,000) for $11,500. This leverage can be controlled and even multiplied by using limited-risk long options as done with the Options Profits Resource Advisor.

A long commodity option position with a $750 premium, for example, ups the underlying commodity leverage another level. Now the maximum risk is the cost paid, which is just a fraction of the commodity worth under control. That small investment can gain value from the movement in over $170,000 worth of gold.

The controlled absolute risk using options is a great way to make the markets work for you instead of you working for the market. Pure and simple.

Be sure to review my video with Jill Malandrino from the floor of the CME to see how it all works.

And HERE is the link to the trade referenced in the video.

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