Recent Events Create Opportunities for Value Speculators

In my opinion, the best values to be found right now are in the short-term interest rate space and the grain and soft commodities, such as corn, soybeans and sugar. Each of these markets have fallen out of favor but appear to be trading at attractive discounts relative to fundamentals.

We tend to be antagonistic in our views. When a particular market or asset has either been forgotten by speculators or, even better, is the target of aggressive emotional selling, we tend to favor a countertrend position. With that in mind, we've spotted a few markets we believe offer opportunities for those willing to speculate "against the grain."

The safety and yield of short-term interest rates might soon be desired

Being long interest rate products, in general, is a highly unpopular idea. However, recent shifts in the yield curve appear to have created an opportunity. For instance, six-month to two-year securities with relatively little default risk are starting to see yields in the 2% to 3% area. At some point, we can't help but feel investors will appreciate the safety and optionality these securities offer. Should this occur, these securities will see price appreciation as well as pay a healthy low-risk yield.

As futures traders, we've been playing the upside of short-term interest rate products using call options on Eurodollar futures, which are essentially U.S. dollar deposits in overseas bank accounts earning the LIBOR rate. Although the Eurodollar market, not to be confused with the euro currency, doesn't get a lot of attention it's the most liquid futures market in the world and is worth a look.

For example, it is possible to buy an at-the-money December Eurodollar call option for about $200; this is a low and limited risk we are willing to take. The world could look completely different six months from now.

A tariff tantrum in grains and softs might have created a buying opportunity

When the average investor thinks of the commodity market, they generally associate crude oil and gold but rarely consider agricultural commodities such as corn, soybeans and sugar. Yet, these grain and softs markets play a significant role in our daily lives and have the potential to provide traders with significant opportunities. This might be particularly true in the wake of the commodity market tariff tantrum.

That said, unlike stocks, which can be bought and held for the long run, commodities are generally short-term vehicles. This is particularly true of the grains and softs because they are annually renewable. In other words, the fundamental story of today could be dramatically different in six months to a year because supply has replenished itself. Accordingly, speculators wishing to get involved in the commodity space must keep their time horizon at a reasonable level.

Ideas on how to play the upside in grains and softs with low and limited risk

Low market volatility in the commodity markets in recent years forced us to consider creative strategies that take advantage of time value erosion while maintaining a directional bias and limited risk.

The best method we have found to do this is the use of a covered call strategy with some sort of catastrophic insurance in place to protect the position from being caught in a black swan type of decline, or even something much smaller but potentially devastating to a trading account. The result is a high-probability venture capable of profiting from any scenario in which the price of the commodity goes either up, moderately lower, or sideways. The risk is in the price of the commodity falling too far, but that is where the insurance policy (purchased put option) comes into play.

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Source: QST

As an example, a trader might consider going long a March sugar futures contract near $13.00, then selling a March $13.00 call option for roughly 93 tics or $1,041.60, then using some of the proceeds to purchase a September (shorter expiration date) $11.00 put for 12 ticks, or $134.40, to protect the trader from a market fallout. This creates a strategy that yields the maximum payout if held to the option expiration of about $900 (before considering transaction costs) should the price of sugar be at the current price or higher.

In other words, although this trade holds a bullish bias, the price of sugar doesn't necessarily need to go higher to achieve the best-case scenario. The only requirement is that the market isn't lower at expiration in early 2019. With sugar trading at a relatively cheap price going into a seasonally supportive period, it seems to offer traders attractive prospects.

On the flip side, there is a risk of the price of sugar melting down below support to create havoc on this trade. Due to the difference in expiration dates of the long put option and the primary trade, it is not possible to calculate a precise risk but we suspect losses should be held under $1,000 if the trade goes horribly wrong (as long as the insurance is still in place).

If you are interested in looking at additional details of this idea, you will find them here. We also put together a similar trade idea in soybean meal last week, which in hindsight appears to have been a little premature but the strategy is working as planned in that it is well-hedged.

Trading in commodities requires often requires thinking outside of the box. Stocks pay dividends, come with limited risk, and have a predisposition to move higher, but commodity futures speculations must be altered via long and short antagonistic options to mimic a similar environment.

Carley Garner is a regular contributor to Real Money Pro. Click here to learn about this dynamic market information service for active traders.

At the time of publication, Garner was long March Sugar Futures, Short March Sugar 13.00 Call Options, Long September Sugar 11.00 Put Options, Long October Soybean Meal Futures, Short October Soybean Meal 350 Call Options, and Long October Soybean Meal 320 Put Options.

*There is a substantial risk of loss in trading commodity futures, options, ETFs. Seasonal tendencies are already priced into market values.