The market appears to be setting up for a continued decline if the earnings next week are worse than expected. It is even possible we could see a continued decline even if the earnings are "ok" simply because we are heading into the dog days of summer and the economic indicators are worsening. This is not an environment to be writing a bunch of naked puts but there are still opportunities if you look hard enough.
The -19% decline in oil prices over the last two weeks is an amazing opportunity. The decline is due to the sudden return of talk by regulators to tighten restrictions on who can buy crude futures and commodity futures in general. I personally think this is a wasted effort since it requires a lot of speculators to make a market in a commodity and give suppliers and consumers a way to hedge their needs. If the administration through the CFTC succeeds in limiting investment in commodities by speculators it may produce a perfect example of unintended consequences. Only time will tell.
Meanwhile crude prices are plunging because of major holders trimming positions to avoid getting caught in some regulatory decision. Lets say you were Goldman Sachs and you have 100,000 crude futures contracts you control. Maybe you wrote swaps against them or produced hedges for some of your larger customers. If the CFTC suddenly says the new position limit is 5,000 contracts then you would have to unwind all those positions. Reportedly there will be some exclusions for true hedgers but until a new rule is actually written everything is just hearsay.
Since Goldman is only one player and there are hundreds if not thousands of big players in the commodity pond the risk is that everyone will have to exit at once if a new rule is passed down from the CFTC. To avoid this hazard those that own large positions today are trimming those positions in advance of a ruling. Thus we have seen the price of crude fall almost daily since July 1st when the CFTC news started.
During this same period we have seen the economic indicators roll over suggesting a double dip recession. The IEA and EIA have both lowered demand estimates for 2009 and OPEC compliance with the production cuts has fallen to 68%. This is the perfect storm for crude prices and speaking of storms it is now the middle of July and not a trace of hurricanes in the gulf.
One last problem is the floating oil storage trade. When oil was trading under $50 back in the first quarter the Q4 futures were trading well over $65. It costs $1 a barrel to store oil for a month. Quite a few major players chartered oil tankers as floating oil storage and loaded up on under $50 oil. The expectations were for the economic rebound that appeared to start in April to continue through year-end and push oil prices back into the upper range over $75. Everything was going so well and the December futures traded as high as $76.50 back in mid June. Suddenly the economic revival hit a snag and new demand numbers began to fall again. If you had a tanker with a million barrels of oil floating peacefully in the Mediterranean you were suddenly losing a million dollars a day as the prices began to decline. When the CFTC chatter started around the first of July the price decline turned into a rout and owners were suddenly rushing to sell their floating cargoes rather than hope for a rebound in the fall. Oil prices in the August contract have fallen $14 in the last four weeks.
Crude prices have declined to $59 and there is strong support at $58. If $58 breaks the next support level is $51. I don't think $58 will break UNLESS there is more chatter out of the CFTC. While oil prices have not returned to their lows from the spring many energy stocks have already succumbed to the selling and retreated to support at Q1 levels. Oil prices will have to drop under $50 before those support levels should break. This has given us several put selling opportunities in the energy sector. However, there is still risk as we saw from the Chevron earnings last week. The energy sector is going to be pounded throughout the earnings cycle. Therefore I am going to create a watch list for future declines to take advantage of any earnings disasters.
Another sector that has been beaten up is the fertilizer sector. POT, MOS and TNH are well off their spring highs on worries that the global recession will impact the amount of money spent on fertilizer. They were crushed back in the fall when overseas fertilizer buyers could not get letters of credit for major purchases. Since fertilizer is required to maintain the yields and supply food to billions of consumers overseas this decline in the fertilizer stocks is only temporary.
I wanted to play some tech stocks ahead of earnings but the Nasdaq is starting to look like a potential breakdown. With the summer months normally known as Death Valley days for techs we are a month or two early to add naked puts in techs.
The MCSI put recommended last week is looking good. With Monday's gap down market open traders could have gotten a better entry and MCSI (MXB) closed at the high for the week on a down week in the markets. If you did not get into this play last Monday you can still enter this week for about the same price thanks to the increased market volatility.
New Recommendation - Conservative
MOS $41.13 - Mosaic
The Mosaic Company (Mosaic) is a producer of phosphate and potash crop nutrients for the agricultural industry. The Company operates its business through three business segments: phosphates, potash and offshore. The Phosphates segment produce phosphate fertilizer and feed phosphate, which are used in crop nutrients and animal feed ingredients, respectively. The principal inputs used in crop nutrients production are phosphate rock, sulfur and ammonia. The Potash segment mines ad processes potash in Canada and the United States and sells potash in North America and internationally. The Offshore segment produces and markets fertilizer products and provides other ancillary services to wholesalers, cooperatives, independent retailers, and farmers in South America and the Asia-Pacific regions. As of May 31, 2008, Cargill, Incorporated owned approximately 64.4% of the Companyâ€™s interest. As of May 31, 2008, the Company had a 50% interest in Saskferco Products Inc.
Sell Aug $35 Put MOS-TG currently $1.50, stop loss MOS @ $33
New Recommendation - Speculative
None this week
XTO - Energy
Sell Aug $28 Put XTO-TY if XTO touches $30
PBR - Petrobras
Sell Aug $25 Put PBR-TE if PBR touches $31
NOV - National Oilwell Varco
Sell Aug $25 Put NOV-TE if NOV touches $28
There are several different formulas for determining margin requirements for naked put writing. These are normally broker specific and some can require larger margin requirements than others.
Here is the most common margin calculation for naked puts.
100% of the option premium + ((20% of the Underlying Market Value) - (OTM Value))
For simplicity of calculation simply use 20% of the underlying stock price and you will always be safe. ($25 stock * 20% = $5 margin)