An Insiders Perspective: Tips and Tricks

 

Futures Trading with the News 

By nature, markets are efficient and all knowing.  Simply put, the price of any given commodity already reflects all available information.  While information that you see on TV or read in the newspaper is new to you, it is not new to the market.  By the time that the information reaches you, it has already been accounted for in the market price of a given commodity.  This is even truer in today’s markets with the advent of electronic overnight markets.  The futures markets are trading nearly 24 hours a day, allowing instant price reaction to new information. 

As a principle, we have found that a trader should never execute a trade solely based on a recently read article or viewed newscast.  Once the information has traveled to you, it is already too late.  This is where technical analysis comes in. 

The market will often tell you the news, before you actually hear it.  You may not know exactly what it is, but you will see that prices are reacting positively, or negatively, to an outside force.  This is the time to be reacting, not after the news has traveled to you.

Trading Economic Reports 

While it may seem exciting, it is generally a good idea to avoid playing in the commodity markets around economic or agricultural reports.  The release of new information to the marketplace often creates an immediate “knee-jerk” reaction that can be very difficult for a futures position to absorb.  Obviously it would be impossible, and irrational, to avoid the release of all reports it is prudent to avoid major occurrences such as the monthly employment report or the Gross Domestic Product readings.

Not only is it a good idea for futures traders to be flat the market during major releases, but in most cases we believe that they should avoid placing trades immediately before or after the announcement.  Market moves have a tendency to be swift and often directionless.  Unless you are much more talented than I, this creates a risky proposition with little room for success.

If you must be in a commodity market position ahead of an announcement that has the potential to trigger a violent move, I believe that you would be best positioned in a directional option spread.  For example, if you strongly believe that a market will drop post announcement, you could sell an out-of-the-money call option and buy an out-of-the-money put option and maybe even sell an out-of-the-money put.  Unlike a futures position that has the potential to immediately create massive gains or losses, an option spread takes some of the volatility out of the trade.  If an option spread is filled at a credit, it is possible to be wrong and make money doing it.  In such a case, the gain would be limited to the premium collected and the theoretical risk would be unlimited, nonetheless the potential to profit from an inaccurate speculation remains.

In essence, assuming that the futures market goes in the direction that you predicted, you may not make as much as you would have had you executed a futures contract but if you are wrong you won’t lose as much.  In fact, depending on how the trade is structured and the time horizon that you are in the trade it is possible that you can be wrong and still not lose money. 

For instance, if you execute a directional commodity option spread containing both long and short options at a credit and the spread expires worthless the trade will be profitable by the amount of the original net credit minus the transaction costs such as commissions and exchange fees.  This is true even if the market doesn’t go in the anticipated direction, assuming that all legs expire worthless.  Of course, such a trade involves naked options and theoretically unlimited risk making a grossly adverse move potentially risky, which is the opportunity cost of executing a trade at a credit. 

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