Trade Changes and "The Basic Trade"

1. I got stopped out of the natgas about ten seconds after the last post. I still believe in the trade, but you have to respect your stop. There are a couple of ways of continuing this. First, natgas vols are quite low, so you could just buy options. Second, you can buy a long Mar/May spread. This probably makes the most fundamental sense. The low price of NG vs. CL will undoubtedly bring demand increases, but it might take awhile. When it comes it is not likely to be short-lived. Just like visible stocks have gone up above average for a few months, they will fall in the same way. Remember, many of the users are buying 3 - 6 month contracts.

2. Today's drop in sugar was what I was waiting for. I added outright futures, not options. I will probably finish off my position another 40 points down.

3. I sold some more of the AA on Tuesday. Partly this was just luck, but I'm getting pretty nervous with this. It was trading exclusively on buyout possibilities. OTOH, Al metal prices have continued to rise for the forward positions, a very good sign. I'll probably buy some back around here.

4. The VIX just keeps on going. This has been my best trade in quite awhile. The stock market is near its high, but the hedge (VIX) is up about 20%! I still have the position, but have rolled forward.

Now is a good time to evaluate the prospects for all commodity equities. So far in '07, they have had a wonderful run, far outstripping both the overall stock market and commodity prices. In my view, most of this was due to an undervaluation last year. The market simply didn't realize that commodity prices were going to stay high for long enough. Also, these are mostly high beta stocks, so the overall equity move has helped.

My valuation work still has them as cheap, based on a DCF/risk analysis. Obviously the undervaluation is not as severe. Given the significant long positions in the market, you have to expect some minor crashes. I have chosen to counter this with a hedge in the VIX. Some of the readers might prefer the more direct route - buying puts on the stocks we are long. Since I think that all vol. is going up, that's maybe even a better idea. However, the important thing is to keep your eye on the longer term - the basic trade is still good and should be kept on. Just get set for a rockier road.