First off, we have Tom Loge’, the option guru from Peregrine Financial Group (PFG) giving us an option variation on the trades we analyze each week. Many of you are already familiar with Tom from his posts at the Traders Helping Traders forum and from his presentations at the PalTalk sessions. Tom has a knack for cutting through all the clutter to get to the heart of a problem and explaining things so that they make sense to almost anybody.

For those of you interested in learning more about trading options, Tom will be giving us a vertical option spread variation on those markets that are showing a directional bias. Vertical spreads are a great way to minimize risk while still providing reasonable profit potential, which is of obvious importance to every trader.

While I’m on the subject of minimizing risk, let me introduce our second new feature which has to do with trading market spreads. We are very fortunate to have Spread-Master Kirk Kristian from Wheatland Investor Services providing our weekly spread analysis.

Spreading markets is a great way to capitalize on the price differences between contract months or in some cases even between similar markets, while keeping risk to an absolute minimum. Another benefit of learning to trade spreads is that in most cases the exchanges will give you a substantial break on the margin requirements. For example this week’s spread has a margin of $0. No, that’s not a typo. You can trade this spread without any money up front. It just doesn’t get any better than that!

If you would like more information about options or spreads feel free to give Tom or Kirk a call. You can find the phone number for both of these gentlemen in the Broker section of the ezine.

Last but not least, this week marks the beginning of our new paper trading section entitled “Pick of the Letter”, where you can look over my shoulder as I paper trade an imaginary $5000 account.

Many novice traders are mystified as to how to actually go about the business of trading, and while every trader has their own unique style, I hope that by seeing how I would trade such an account it might make things a little clearer for you. And who knows, with a little bit of luck we might even be able to make some paper trading profits at the same time. ;-)

Enjoy this week’s issue.

Corn behaved itself nicely last week, pulling back to the resistance we outlined at 237 ½. Unfortunately declining volume and open interest figures suggest that the trend lacks strength to continue, and without a boost in volume it is likely we will see the downtrend resume next week. To be on the safe side we could treat the range of the last three sessions as a channel formation and bracket the trade to let the market tell us which way it wants to go.

A break through the top of the channel at 237 ½ should see prices continue higher to the resistance in the middle of the gap at 239. If the market does not reverse out of the gap look for it to continue higher to the next resistance level located at 246.

The bottom of the channel is the low of Wednesday at 234 ¼. A break through the short side should see the market continue to the recent low at 228 ½. Below here the market quickly encounters more support at 225 ¾ and the contract lows at 224.

Cotton made a strong move down last week, stopping just shy of the support we outlined at 4905. After encountering this support the market reversed and looks like it is pulling back this next week before possibly heading lower again by the end of the week.

If the pullback continues on Monday look for the resistance at 5075 to slow the market down and maybe even send it lower again. If this resistance does not hold look for the next stop to be around the resistance located at 5170.

If prices continue lower, look for support at the recent low of 4911 and the support just below it at 4905. This would be followed by the 50% retracement of the October to January uptrend at 4863. Once below here the market would next encounter support at the low of the recent uptrend at 4800.

Beans treated us very nicely last week by doing as we hoped and recovering much of the dramatic decline from a couple of weeks ago. Unfortunately, while the rally has been quite impressive it has been happening on falling volume, which is usually a signal that the uptrend could be weakening. With the market currently in the middle of the gap with resistance just above it at 572 ½, it appears that we could be in for another reversal in prices next week.

If we see bean prices turn next week look for the market to retreat to support at 549 and the recent low of 544. If these support levels breakdown, look for added support to be found at 536 and the bottom of the large trading range at 530 ½.

If beans close above the resistance level at 572 ½ look for prices to continue higher to resistance at 585. Once above 585 beans will be in a position to challenge the contract highs at 593 which is also the top of the range that has confined the market since mid-September. As always, make sure to watch the volume figures to make sure the rally has some momentum to it.

Cattle gave us the pullback we were looking for last week, getting as high as the resistance at 7865 before once again reversing and heading lower. The market seems to have completed a 123 top formation with current support just above the neckline. While it appears that in the long term prices are heading lower, Friday’s trading closed very near the high; thereby indicating that we could be seeing more of a pullback early next week.

If prices do pull back higher look for resistance again at 7865 and slightly higher at 7920. Above here the market could be in a position to challenge contract highs at 8015; however that does not seem like a likely scenario at this time.

A break below the support at 7710 would complete the breakout of the formation and signal that the bears control the market. First test of a downtrend can be found at the support located at the top of the gap just below the formation at 7670. Below here there is more support at 7535 with harder support found at 7500. Once below here the market would be in a position to complete a 50% retracement at 7338.

Like several contracts last week, cocoa continued to climb higher despite decreasing volume figures; thereby showing a lack of bullish momentum. The market even managed to test the resistance at 2250 before backing off last Friday. It appears that the market might be getting ready for a reversal but the big question is when to expect it.

A break above the current resistance at 2250 could see the market test short and long term resistance at 2300. While the market is definitely in an uptrend, given the strength of the nearby resistance and the lack of volume so far, it would be wise to be cautious of any moves to the upside. The market will need more momentum than it currently has to reach the next level, so look for increasing volume on a possible breakout to help support a bull move.

If the current high holds look for the market to pullback to the initial support level at 2120. There is a fair amount of support here, but probably not enough to keep the market up. If prices continue to decline below here look for added support at 2055 and eventually 2008 as well.

Sugar continues to buck the seasonal trend by setting yet another new contract high before the end of last week. In spite of advancing prices I can’t help but feel that the bottom is due to drop out of this market soon.

The weekly chart shows the market trading very near the long term 50% level thereby simultaneously completing a rounded bottom formation with the 50% retracement level at the neckline. Furthermore volume figures have not been reinforcing the bullishness exhibited by the rising prices, indicating that the market might be topping out soon.

The market is currently against some long term resistance, with more upward resistance very close by at 810 followed by the weekly 50% level at 820. If prices finally retreat, as they usually do this time of the year, look for first support at 755 follow by more support at 730 and 715. If the market manages to break below these levels look for final support at 690 before the market would be in a position to attempt a 50% retracement at 662.

Short term long positions look unpredictable until the market can clear the resistance at 810 and the weekly 50% level at 820. If sugar manages to trade this high, look for next resistance to be found at 850. Any bullish move should have increasing volume to sustain the trend.

The Swiss Franc continued to push higher last week before finally topping out at 7415; although, it looks as though we might be in for a pullback next week. This week’s rally came on decreasing volume which is usually an early indication that the trend is losing steam. This combined with divergences occurring on some of the secondary indicators like MACD and RSI tend to further hint that a pullback is imminent.

While this is normally the time of year that we see the Franc making contract lows, the treat of war in the Middle East continues to support this market. Although it seems that we are due for a pullback there is no indication that it will be a full reversal at this time. Given the world tensions it seems reasonable to assume that the Franc could continue higher in the long term.

If we see prices fall off next week look for initial support at 7260 followed by 7220 and 7180. There is added support just below the 62% retracement level at 7127, but the more serious support seems to come again around the 50% level at 7052. It seems unlikely that the market will get much lower than the 50% level at this time as it would threaten the viability of the current trend.

If prices continue higher they don’t have too far to go before encountering more long term resistance at 7490 and even harder resistance at 7555. The market will need some serious momentum to get through these levels, so be sure that volume is increasing with prices or the rally will be short lived.

Silver continued to trend higher last week, completing a rounded bottom formation in the process before the weekend. While the market continues to challenge the resistance at 495 it has so far been unable to post a close above, or even near the resistance level. This shows that while the bulls can push prices higher, they currently lack the momentum to keep the prices high before the market closes. In essence it might be a sign that the market is rejecting the higher price.

Fortunately the market has completed a rounded bottom formation which we can base this week’s trade on. If the market can post a close above 495 this should be a strong signal that the bulls retain control of the marketplace and higher prices should result. The next resistance to be aware of is found at 503 followed by resistance at 507.50. Above here it should be fairly clear sailing until the resistance near the contract highs at 517.

If we see the market retreat from the resistance at 495 look for nearby support at 472. This would in turn be followed by support at 465 and the 50% retracement at 462. If the market manages to pullback this far we could expect it to test the support at 455 as well.

As a rule, the more money you begin with, the greater your likelihood of long term success, at least in most cases. However, we chose $5000 as our initial account size as it seemed to be the most popular starting figure for new traders, and after all, the whole point of this publication is to help you become a better trader.

Given the nature of the markets there might not be a paper trade worth taking every week; however that is part of the business. Remember there are three positions we can have in trading: long, short or flat (not in the market). Our objective will be to build the paper trading account as quickly as possible, in as safe a manner as possible.

So follow along as I paper trade this account. Hopefully by looking over my shoulder you will get a better understanding of how the trading business works: where we enter the market, where and when we move stops and where we (with any luck) take profits.

Note: it is VERY IMPORTANT that you do not interpret any of this as a trading recommendation, IT IS NOT! As I’ve pointed out already, there is a 50% chance that we could be successful as well as a 50% chance that we could bust the account. There is SERIOUS financial risk in trading futures and options. Do not trade anything we paper trade here with real money! The sole purpose of this exercise is to help develop your own paper trading skills. Understand? Good.

For our paper trades we will assume a round turn commission of $35, plus an additional $15 to allow for slippage and miscellaneous fees. We will use Gecko’s nifty trade tracking feature in Track ‘n Trade to keep track of our positions and automatically calculate our profits and losses. If you’re interested in seeing what the software is like for yourself, you can get a free trial of Track ‘n Trade software click here

Everybody ready? Okay, here we go….

Now that April Cattle have completed a 123 top they might be setting up for a reversal from the uptrend in the next few weeks. The seasonals and technicals all seem to be in harmony right now, so it looks as though we might see lower prices in the near future.

The risk/reward ratio for this particular trade is 2:1, which is my minimum acceptable standard for placing a trade. Profit target is the 50% of the large uptrend at 7338. I could have made the trade more favourable by placing the stop loss order above the resistance at 7815; however this would have been within the trading range of last Friday and a little too risky.

I normally do not like to have quite this much money at risk when I take a trade; however I am confident that if the short order is engaged the market will continue down thereby enabling me to lower my stop to a more acceptable level. I would rather have the stop a little looser at the beginning of the trade than make it too tight only to be stopped out prematurely before the market has a chance to go anywhere.

[I would also consider doing this trade as an option spread as well in order to minimize the risk.]

I might have risked a tighter stop if the market did not close so high on Friday; but since the market closed high it could be an indication that it is not done pulling back yet. Therefore, to avoid having my order engaged too soon, I placed the entry order a little farther away to make the market come to me before engaging the order. Entry is at 7697, below the support at 7710 and 7700. Once filled the initial stop loss will be above the #3 point at 7877.

If the market takes out the #3 point next week before engaging the short order, I will remove the short order and wait for the market to form resistance at the new #3 point. Ideally the new #3 point resistance level would be near the contract high, and with a smaller range ($300 +/-) of risk between the high and lows of the #3. In such an instance I would probably take an order short below the lows of the new #3 with stops above the new #3, or #1 point if feasible. Keep your fingers crossed. ;-)

As the name suggests, a trailing stop is a stop loss order that is moved to trail a profitable market. It can be a very effective strategy, especially if you are anticipating a larger market move, as it locks in profits as you earn them. However if you trail your stop too tight you might be taken out of the market too soon.

This then is the challenge with trailing a stop: knowing when and where to move it. Frequently when traders refer to the "art" of trading, they are actually talking about effective stop loss placement. Determining the best way to trail a stop loss order depends a lot on your objectives as a trader.

If you are looking at a short time frame trade, or perhaps a couple of days to a week, you will likely have a smaller profit target and therefore will keep a tighter trailing stop. Assuming we are making money on a long position, in such an instance it would be feasible to simply move the stop a few points below the previous days low. Since we are only in for the short term, we will be taken out of the market on the first sign of hesitation or minor reversal.

If you have a longer term focus for your trade, one of several weeks or months even, then you will keep a much looser trailing stop. In such a scenario, again assuming a long position, you would likely move your stop below support as the market makes its occasional pullback moves every couple of weeks or so.

This will allow you to stay with the market for the maximum duration, thereby capitalizing on the majority of the trend, a good strategy especially if you are able to enter the trend near the beginning. However keeping a loose stop will also mean that you will have a lot more money at risk since your stop loss will not be engaged until the market makes a full blown reversal from the current trend.

Through practice and experience most traders will adopt a variation of the two extremes. For instance, I like to leave stops fairly loose, tucking them below support as it forms and tightening them when I see the market forming resistance (assuming a long position) in anticipation of a pending reversal or pullback. This would be especially true if I had earned a fair amount of money with my trade already and I wanted to conserve as much of my profits as possible.

For example, a few months ago the cocoa market peaked as it encountered long term resistance. By immediately tightening my stop below the low of the formation I was able to lock in the maximum profit for the trade before the market eventually reversed. Had I kept a looser stop after encountering resistance I would have lost a lot more profit before finally being stopped out of the trade.

It is a bit of a judgment call, but through paper trading experience you should be able to develop a “feel” for what is right for you.

Erich

Erich has graciously offered to share some space in the E-Zine with me. Thanks Erich!

Each week I will be offering up some option Vertical Spreads compatible with Erich’s directional bias. There will be times when circumstances will perhaps make it more comfortable or feasible to opt for an option position over a futures contract. The margin may be to steep, the gap back to the appropriate stop may be too large, there may be major reports due during your judged holding period or you might just have that feeling that this is not the right time to step up without a tighter risk management afforded by the defined risk of an Option Spread.

Please feel free to submit any questions you have on Options to the webmaster here, I’ll do my best to answer 2 or 3 a week. So here we go with our first pass …

On Thursday last week we popped through the resistance at 2200 only to fall back and open at 2200 on Friday before settling at 2187. As you know from the fundamental news out of the Ivory Coast there is renewed political unrest occurring over the weekend putting a damper on the peace accord initiated late last week … Very volatile situation!! I would not be surprised by a major move either way on Monday’s open. I would assess again AFTER the open. If you feel the downside will ultimately prevail then I think the best course would be to look at the May Cocoa Options. Man, are they expensive!! Astronomical Implied Volatility. I don’t see a Reward/Risk scenario in any combination of puts with which I feel comfortable. I would stand aside in this market at the moment and see where the dust settles.

Although we are looking at the March Corn contract to identify our action numbers … those are the numbers disclosed by the chart as the entry, stop loss and profit target prices … with only 27 days until expiration I think we need more time. The only 2 events likely to move prices higher are problems during the planting season or hot, dry weather during the critical periods of growth … March/April and July/August respectively. Therefore, I’d suggest looking at July options minimally and September options probably more appropriately.

Initially I see sitting right on Erich’s strong support at about 2.35. My stop, were I going to trade a contract, would be placed just below the recent lows at 2.28 ½ … say, 2.27 ¾. My initial target is the resistance overhead in the 2.65 range, but we all know what we are really looking for is something above 3.00 at least. It would however be foolish to ignore that resistance at 2.65.

July Corn is about 5-6 cents higher than March. I would buy the July Corn 240 Call at 14 cents and sell the July Corn 2.80 call at 4 cents. The debit then is 10 cents or $500. I would risk the spread to 5 cents ($250 loss) or close it if March Corn Futures trade below 2.27 ¾ which ever happens first. My reward in this trade is 40 cents or $2000 minus the cost of acquisition of $500 for a max profit potential of $1500 … a 3:1 reward to risk. In actuality, however, I am only risking a maximum of $250 …soooo, my real reward to risk is about 6:1 is it not?

If I go all the way out to September options I would work the same strike prices attempting to buy the Sept Corn 240 call, sell the Sept Corn 280 call for the same 10 cents … it’s a little more expensive than that right now … and use the same management theory. When March goes off the board, I would look at the July or September chart and identify new “ACTION NUMBERS”.

I certainly agree with Erich on this one. Make sure you look at the weekly chart as well as the March daily. The daily looks a little “thread bare” near the top …especially if you look at the charts with Candlesticks as opposed to bars. I also think that upside is fairly well limited to 5.15. Given the support identifiable at about 4.80 I think my play would be with a futures contract here … a buy with a stop at just below 4.80. Were I especially short funded I might look at March Silver Calls. I would consider buying the

March Silver 4.90 call and selling the March Silver 5.25 call. The debit would be 7-8 cents … $350-$400. I would risk the trade to March Silver trading to 4.75 or one half of the net premium I paid. Worst case this should give you a max reward of 35 cents or $1750 minus the $400 cost or about $1350 …a little better than a 3:1 reward to risk. Again I am really only risking half my net cost so the r/r then looks more like 6:1.

With the dollar having walked off the edge of the cliff the Swiss should continue to inch higher UNTIL the dollar can find a foothold or a protruding branch to grasp. Currencies, once in a trend, tend to make a long run. Given we are at recent contract highs (look at that weekly again) one would suspect we might be reaching a bit of an exhaustion point … you can’t continue manufacturing new buyers indefinitely. I do think it is a little premature to be thinking a sustainable down move is in the cards but, I also have difficulty bringing myself to jump on the up bandwagon at this juncture. This may be one of those we just have to admit we missed. I see no option spread that makes any real sense. I need a chart that’ll talk tome a little better …

Well, Erich tells me this is his “Pick of the Litter” for this week. Let’s see what we can do here. The directional bias is down so let’s first get our “ACTION NUMBERS”

Friday’s close was .7812. The chart clearly tells us the stop loss must be placed above the highs from 3 weeks ago … about 8020 is the number I’d say. So to short here with a stop back to 8020, puts our risk in a futures trade at roughly 200 points or $800. Too rich for my blood let alone my account, so if I decide to play it will definitely be with an option spread. Hmmm, some fairly strong support at about .7670 with a little “weenie gap” just below that makes for a rather limited profit potential. I can see from the weekly a shot at .7400, though. Maybe even a shot at the 50% number at 70.00 but, I think it’ll have to take some time to deal with .7200 before getting there. Ok, we got the “ACTION NUMBERS”, let’s look at the options.

I think I’d buy the April Live Cattle .7800 Put and sell the April Live Cattle .7300 Put For a net debit of about 130 points or $520. My max reward in this position would be 500 points or $2000 less the $520 or $1480 … just shy of 3:1. Now remember we are going to use our “ACTION NUMBERS” from the charts to manage this position. If April Live Cattle trade 8020 we are going to close out the trade but in no event do we let more than half what we paid for the spread go away. In reality then we are risking $260 to possibly make $1480 for a reward to risk ratio of 5.7:1.

On a move in our direction we take whatever profits are available if April Live Cattle trades .7000, I think we’d also take it at .7200 … at .7400 we are going to watch it real close. I would submit having touched .7400 with a pullback to .7470 or so causes me to bail as well. Further, a trade to 7650 that doesn’t pierce it with some real momentum and power probably has me heading for the bank with a little profit as well.

I hope I offered something of value here for all of you. Use this as an assessment tool if you’d like. Did you “get it”? Did you follow most of it with some blind spots? Did you follow some but got lost along the way? Was it total “Greek”? Pop me an email and tell which of the 4 groups you fell into, I’ll give you some educational direction that’ll take you the rest of the way.

Have a great trading week all … I’ll be back next edition of Erich’s E-Zine.

Tom

R. Thomas Loge', CTA 1.800.656.0443 rtom816@att.net

By buying one contract month and selling another, the basis behind making money in spreading markets is to profit from the price difference between contracts. Therefore it is not always necessary to determine where the market is heading next; rather we want to know how the different contract months will react to each other. This week we are looking at the long October, short March Soybean Meal spread.

The spread difference should be no less than -9.50 and the closer it is to -12.00 the better. If the spread pulls back to -14.00 by all means, take it. Traders should risk $5.40/ton on the spread with a profit objective of at least $5.30/ton.

Margin for this spread at the moment is $0.00. That's right $0.00. IF margin does "kick in" we expect it will not go beyond $200.00 per spread.

Background

Old-crop soybeans normally suffer most heavily from the phenomenon known as the "February Break." Cash prices tend to recover after harvest as producer selling slows, but the new calendar year is also a new tax year. Producers, unable to work their fields anyway, spend the time converting grain into income. But grain supplies build at local elevators because inland rivers freeze and flood, slowing distribution to export and user terminals. Thus, interior locations lower their cash bids, and deliverable supplies, with nowhere else to go, can become burdensome.

Also, South American crops are being made and, by April, replacing US soybeans in export markets. So too for soy meal, the US domestic consumption of which also declines into summer. Meanwhile, market focus shifts increasingly toward new-crop prospects, driving new-crop/old-crop spreads in both soybeans and soy meal.

You may wish to look at bear spreads in the Soybean Meal market. Generally, when agricultural prices decline, the front months decline more than the back months, especially “old crop” vs. “new crop.”

Current Situation

This spread "ran" this past week, a bit ahead of our expectations. Last Friday we saw a pull back and we are still entering this trade between 9.50 and 12.00 spread difference premium the March Meal.

In 14 of the last 15 years, October Meal has gained in value relative to March Meal from January 14th through February 27th. With Meal being the weakest member of the Soybean complex for the last couple of months, it is our opinion that Meal will be heavily hit in any February Break this year, thus benefiting the spread.

Like all of our recommendations, we strongly recommend that clients take a moment and think about this trade. It has been our experience that reflecting on the trade, has allowed clients get in at better prices about a third of the time, while in a third of the cases as good trade is missed or less attractive prices are received, and a third of the time a trading loss can be avoided.