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In This Issue:
Chad Butler of RJOFutures discusses trading ideas for the new year, including which markets may be hot.

January 18, 2007

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Trade Ideas for 2007

As we enter a new year, one of the first things I try to do is evaluate markets and develop a picture of what to expect in 2007, both in terms of fundamental and technical analysis. This gives me some idea of what my trading plan will be for the year, what markets to focus on, and where the action is likely to be. Like any trading plan, this yearly evaluation must remain flexible. Weather, geo-political events, natural disasters, and even bumper crops can all be unpredictable. Situations change and any trading plan must be able to change with the environment. With that in mind, I would like to discuss one of the market sectors that I think will be in the forefront for 2007 – the Grains.

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The grain markets continue to be on everyone’s mind. Will we see record high prices? How high can corn go? What will be the effect of the food vs. fuel debate? These are just some of the questions on everyone’s mind, and there is no exact answer. But the grain complex will most likely be the star player of 2007.

We have the makings of “The Perfect Storm” in the grain complex for 2007 – global demand, an El Nino year, falling stocks and stock to usage ratios, and there are just only so many acres of cropland available to fill demand. Corn is the current popular player in the unfolding ethanol story and this will likely continue during 2007. Higher prices as a result of increasing demand for ethanol production could be assisted by a continued El Nino weather pattern into 2007.

With corn pushing closer to record prices, there is a fear that acres of soybeans will be lost to corn. This supply concern has pushed current bean prices higher, in light of the fact that we have record supply. This will be an area to be cautious in as the technical and fundamental picture of the market are currently in opposition. In the Soybean complex, bean oil has the advantage of being in demand for bio-diesel. As for bean meal, the supply picture in beans will likely weigh on meal.

So what does all this mean? And more importantly, how can you as a trader benefit from the current market situation?

The chart below is March Corn. The market is showing signs that it is ready to begin another leg up. The market has broken out to new highs, moving averages have a bullish cross, and the MACD is set up for a bullish cross. However, our strongest support is way down at the low of 352 ½ made on 1/10/2007.

Chart Copyright 2007 FutureSource

Current market activity suggests that corn will be fairly volatile for the foreseeable future. For me, that means looking for limited risk positions. Certainly, the futures will provide you with the best possible reward, but with increased reward comes increased risk. If you are willing to trade some of that potential upside for less risk, then a call spread in the options may be appropriate.

A bull call spread provides the trader with a limited risk position. The most that can be lost is the cost of the position. In exchange for that, the trader also has limited upside. The most that can be gained is the difference between the strike prices less the cost of entering the position.

For corn, I want a position that is as close to the current market price as possible, with a long amount of time to expiration. I don’t want it to cost too much – around $1000, with a decent risk:reward ratio, 1:3 being ideal. Here are two possibilites:

December 400/450 Bull Call Spread

This spread is constructed by purchasing the December Corn 400 call and selling the December Corn 450 call. Currently, the theoretical value is about $650. The highest possible gain would be achieved if December Corn were at or above 450 at expiration. This would be $2500 less the $650 cost of entry, for a total of $1850. That fits our above criteria for the same amount of risk as a 13 cent move in the underlying corn contract.

September 400/500 Bull Call Spread

Getting a wider spread will be a little more expensive, but it also increases the upside potential. In order to keep the cost down, we will trade some time value by moving in to September. The spread will buy the September 400 call and sell the September 500 call. The current theoretical value is $1350 with a upside of $5000. Subtract the cost of entry and the maximum possible gain at expiration is $3650, close to our 1:3 target.

Keep in mind this market is moving. By the time this is published, it may be advantages to look at lower or higher strikes, depending on market conditions and premium costs. I suggest speaking with one of our trading strategists prior to making any decisions.

This information should give you some markets to keep an eye on for the coming year as well as some to avoid. Unfortunately, time and space do not permit an in-depth consideration at this point. For more in depth analysis of corn, as well as other market, I suggest the 2007 Commodity Guide. RJOFutures is providing a complimentary copy this week to readers of TraderSavvy. The Guide is loaded with in depth analysis, fundamental and technical information, and price outlooks for major commodity markets. It is an indispensable tool for every trader.

Additionally, our experienced strategists can assist you in developing a trading plan for any of these opportunities, be it based on technical or fundamental analysis.

As I have written many times before, the commodity bull market is set to continue. Remember, not all markets go straight up, and not all markets participate at the same time. Be sure you are in the right market for your plan.


About Today's Author:

Chad Butler is a Senior Market Strategist with RJOFutures, a division of R.J. O'Brien. His 16 years of market experience includes option spread trading, diversified trend following, and development of a number of index arbitrage programs. Chad’s published work appears in McGraw-Hill's Complete Guide to Single Stock Futures, Futures Magazine, and other trade publications.  He currently writes for various commodities newsletters, including RJOFutures MarketNews and has been a featured seminar speaker teaching his various trading techniques to audiences large and small.