A Note for the Serious Investor:
The material that follows is written for high-net-worth and accredited investors who are serious about understanding the use of commodity options in a professionally managed portfolio. Futures and options involve substantial risk of loss, are not suitable for all investors, and only risk capital should be used. This article is for educational purposes only and is not a recommendation to buy, sell, or hold any specific futures contract, option, spread, or commodity position.
If there has ever been a more controversial, misunderstood, overregulated, in-and-out-of-vogue tool for “forecasting” certain commodities prices, it is seasonal tendencies.
To define, seasonal tendencies or “seasonals” as they are known, are the tendencies of the price of a commodity to move in a certain direction during a certain time of year.
There was an author that came out with a book several years ago that made himself semi-famous overnight by publishing a series of “can’t lose” commodity trades based on seasonal tendencies. This gentleman was big for a few years. He got himself some TV appearances. Started publishing a newsletter. Had a few high-profile calls on the market. And then, everybody found out that you could lose trading commodities. And the whole phenomenon faded pretty quickly. People stopped paying attention to seasonals.
Seasonal price tendencies often develop as a result of certain commodity “events” that happen at the same time each year.
All of this, of course, is a shame for the investing public, but good for you. For this was a clear case of throwing the baby out with the bathwater. The mistake was not using seasonal tendencies. The mistake was in misinterpreting how to properly use them — in particular, relying on exact dates as entry and exit points rather than viewing the tendency as a general directional bias in a given time period. But that is a subject for another day.
Used correctly, seasonal tendencies can be a powerful tool for commodities investors. I felt them so important that I have devoted significant research time to them in my work at OptionSpreaders.com.
The good news is that seasonal tendencies are still alive and well in the commodities markets and available to anyone that wishes to interpret their compelling data. No, they are not perfect. But they cannot be discounted as a major fundamental factor in almost any commodity market. In fact, I often use them as a starting point when analyzing new option trades.
Seasonal tendencies do have their drawbacks. First and foremost, past performance is not indicative of future results. Just because it happened last year, or even the last 10 years, doesn’t mean it’s going to happen this year.
Seasonal tendencies are just that — tendencies. This means prices have, in the past, tended to move in a certain direction during a certain time of year. However, there are no guarantees as to what point in that time period prices will move, how far they will move, or if they will even move at all. There are no promises made that prices will not spasm sharply in the opposite direction than they are “supposed” to move, right before aligning with a seasonal tendency.
It is true that commodities “seasonals” have their limitations. However, it is my experience that the difficulties of seasonal analysis are more of a problem for futures traders than option sellers. Futures traders have the burden of having to pick market direction and have nearly perfect timing. This makes trading futures contracts in line with seasonals more difficult.
For option sellers, however, seasonal analysis can pack a more powerful payload. As if you need more reasons to sell options, option sellers are not burdened with the responsibility of perfect timing, they may be able to withstand short-term moves against their position and they are more than willing to wait for a move to occur. After all, the option seller is not necessarily looking for the market to perform on command. In many cases, he is looking for time decay to do its job.
But one cannot blindly assume that prices will automatically move in a manner consistent with a seasonal chart. Seasonal tendencies are driven by underlying fundamentals that tend to happen at the same time each year.
For instance, soybean prices tend to gain strength after the U.S. autumn harvest as demand begins to whittle away at storage supplies. This trend can often continue into spring as anxiety over planting influences trader attitudes.
The mistake that novice traders make with seasonals is the assumption that these tendencies provide you with an exact roadmap of what prices should do. The novice may assume from the chart below that if you buy soybeans on October 1 and sell it in February, you will be assured a profit. It’s just not that simple. What if harvest finishes early or the crop comes in smaller than expected? Prices could react sooner and you would miss the move. What if the crop comes in larger than expected or something happens to crimp demand? You could buy right before the market begins an “unexpected” move lower, or simply doesn’t move at all.
Note to Chart Readers: The numbers on the left of the chart do not represent absolute prices but rather, a percentage of lowest and highest price for the year. It is the overall pattern on which option selling investors should place their focus.
The above is an average of price movements only. Individual years may vary. Past performance is not indicative of future results.
This is why option selling is preferable to trying to trade the actual contracts on a seasonal move. The option seller may still benefit from time decay if he is early, late, or even if the expected move is muted. Not so for the futures trader.
But this is not automatic. A sharp move against the position, a change in volatility, or a poorly selected strike can still create losses.
You must also be careful not to discount the relative nature of seasonal tendencies. Think of the opposing factors moving different commodities prices as two weights on either side of a seesaw. Rarely is all the weight on one side. Seasonal factors can put more weight on one side of the seesaw. However, that does not mean that an even heavier counterweight cannot come down on the other side negating the seasonal effect. A wise option seller should always give seasonals their due. But they should be taken within the context of the overall fundamental and technical picture.
Conclusion
At OptionSpreaders.com, we almost always consult a seasonal tendency chart before considering positions for our option-selling portfolios. While you cannot always base a trade on them, I believe they can be an invaluable tool for option sellers. Just don’t always take them at pure face value. Knowing the fundamentals that drive these tendencies will give your seasonal analysis more valuable perspective.
However, for me, combining seasonal tendencies with the strategy of selling options may pack a powerful punch. Knowing them may give the fundamentally minded option seller an added perspective that purely technical traders may overlook — an “ace in the hole,” if you will.
An option seller is interested in stacking every advantage in his corner before placing a trade. Knowing seasonal tendencies is a big one you can start using right away.
If you are an accredited or high-net-worth investor who would like to learn how you can start incorporating seasonals and fundamentals into an option-selling portfolio with OptionSpreaders.com, be sure to request your complimentary Info Pack and The Option Selling Solution at OptionSpreaders.com.
Justin Cardwell
Director of Research at OptionSpreaders.com
For more information on managed leveraged option selling accounts with OptionSpreaders.com, request a complimentary Investor Information Discovery Pack here or call 888-383-2779 to schedule a free consultation*. (*Qualified investors only. From outside the US call +1 813-999-0026.)
