A Windfall For Bear Traders

Sit back. Take a deep breath. Breathe.  If you are an investor who is long assets, a business person, or a citizen of the free world, it has been a long, traumatic week.

We don't need to rehash what happened. We don't need to go into long winded explanations of what is causing it and/or how to fix it. You can go to hundreds of different websites and/or news media and get all of the coverage you like.

However, if you can clear your head for long enough, were wise (or lucky) enough to keep some equity in cash, and you are of the opinion that the sun will come up next week with governments and financial systems still functioning, you may want to look at an idea for actually profiting from this whole mess.

I heard a reporter from CNBC today stating that with all asset classes falling in value and T-Bonds offering virtually no interest, investors really have nowhere to place funds with hope of profit.

Wrong.

In our last three columns dating back to August, we have recommended getting short Euros, Silver and Unleaded Gasoline respectively.  We did not, of course recommend short selling (now a dirty word) but rather the strategy of selling calls. As these markets have all collapsed in recent weeks, our strategy for profiting from the fall now looks a bit conservative.  Nonetheless, selling calls in commodities, foreign currencies or even stocks for that matter, has proven to be a handsomely rewarding strategy for those handful of investors that did not limit themselves to buy and hold asset investing.

This is not the time, however, to toast those investors making profits. The financial storm engulfing the markets is bringing pain to many and we are all going to feel it's effects to one degree or another.  But while markets continue to price in a recession or worse, wouldn't it feel better to be profiting, or at least hedging your other long investments, from further price declines?

Commodities have collapsed right along with stocks, albeit for different reasons.  While some have villanized short selling in stocks as "un-American", nobody was complaining about short sellers driving oil back under $80. In fact, the media seemed to think that was quite American.

As a call seller, you are not short selling anything, nor are you directly affecting the underlying price of a commodity. You are simply betting against another speculator willing to buy that call. He thinks the price of that underlying will move higher. Surprisingly, there are still many willing call buyers out there willing to buy call options from the sellers.

In our previous columns, we speculated that prices of many commodities from energies to grains to metals would begin to decline as the global economy slowed and demand fell. What we did not count on was the rapid surge in the US dollar. The dollar is gaining strength as global economies suffer through the maelstrom and money pours into US Treasuries as a safety hatch.

This has created a "super-bear" market in many commodities as the triple punch of falling demand, a surging dollar and hedge fund margin liquidation are driving commodities prices sharply lower.

Call buyers are now anxiously awaiting any type of rally in commodities as an excuse to buy more calls to be in position for the "big turnaround."

While one must assume that a corrective rally is probably imminent at some point along the way, we wouldn't bet on any longer term downtrends reversing anytime soon.

Even if world leaders and economist can eventually stabilize the financial markets, the recession is just beginning for global business.  Increased destabilization in financials and a surging US dollar could be an accelerant to further commodity devaluation.  However, even in the best case financial market scenario, falling global demand has yet to really kick in, and that alone should prevent any sweeping longer term rallies in commodities.

For that reason alone, we recommend selling calls on a basket of commodities on any short lived rallies over the next two weeks. Our personal favorite remains in the energies as we think this will be one of the hardest hit commodities of a global recession.  Those that think they already missed the boat on bear market call sales may want to consider the fact that stock market assets have declined all the way back to 2002 levels.  Global demand for physical products will probably have to follow suit. Food for thought:  In 2002, crude prices were at $25 per barrel, silver was at $5 an ounce and soybeans were just over $4.00 per bushel.

In times like this, it can be tough to focus on profit opportunities, especially if you have a wide exposure to equities.  However, if you can look through the smoke far enough to see there are some investors profiting in these conditions, you may want to consider how you can do the same.