Futures For You


INSIDE THE FUTURES WORLD

Want to learn how the futures markets really work? Dan O'Neil, a principal at online futures and forex broker Xpresstrade (www.xpresstrade.com), responds to your questions about today's futures markets.

To submit a question, post your question to our website at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C.
Dan O'Neil

HURRICANE SEASON

We've been hearing more about the upcoming hurricane season because of last year's record damage. Obviously, severe weather can wreak havoc in some commodity markets. What are a few futures markets to look at in terms of potential storm-related shocks?

While nobody likes to think about profiting from a natural disaster that up-ends so many lives, the fact is that many commodity markets have long been subject to the ebbs and flows of weather. In fact, weather is one of the challenges that many commodity producers face, and futures and options contracts were designed largely to help producers manage and mitigate such risks. In many of these markets, weather-related action just naturally opens up opportunities for speculators as well.

As another hurricane season bears down on the southern coastal US, activity in orange juice, one of the true weather markets, figures to give traders a daily dose of volatility. Frozen concentrated orange juice (FCOJ) futures have always been subject to a variety of supply-side pressures, but a recent price climb to levels not seen in 15 years, combined with the severity of the past few hurricane seasons, make the outlook for the remainder of 2006 particularly intriguing for speculators. While other factors such as disease and processing capacity can also affect FCOJ pricing, the major determinant of short- and long-term supply has been and continues to be weather.

In recent years, Florida grove concerns like frosts and freezes have taken a back seat to the violent storms and their potential for widespread devastation. As evidenced by the destructive Atlantic hurricane season of 2005, which included the highest number of hurricanes and tropical storms on record and the most Category 5 hurricanes in history, the world's weather patterns are growing more unstable, and the annual six-month storm season is being watched more closely than ever by Sunshine State produce growers and experienced futures traders.

Savvy traders looking for high-risk/high-reward opportunities can address the possible effects of the upcoming hurricanes on Florida's orange crop by participating in the FCOJ futures market at the New York Board of Trade (NYBOT). FCOJ futures trade in the traditional open-outcry pits of the NYBOT, and over many years, juice has consistently been among the most perilous commodities to navigate. But it's precisely this turmoil that can lead to an abundance of speculative opportunities for both bulls and bears, and for this reason, juice futures (and options) have always been popular among individual traders. Just as hurricane season promises volatility and unpredictability, FCOJ traders should be prepared to weather an often chaotic and uncertain market.

WEATHER AND ENERGIES

Hurricane Katrina also demonstrated the power of these strong Gulf storms to cause disaster on the nation's energy production. While most of the recent action in the energy markets has centered on crude oil and the unsettled situation in the Middle East, the refining capacity of the Gulf bears watching in relation to another important market -- unleaded gasoline. The most common, straightforward means of getting into the gasoline game is via futures contracts traded on the New York Mercantile Exchange (NYMEX). Small investors can utilize the power of leverage offered by futures contracts to enjoy magnified profits when favorable price fluctuations (remember, however, that leverage is a double-edged sword).

One of the pitfalls of futures contracts for new investors is often the inability to define and maintain a clear investment strategy when the market begins to move. Given the sizable position that can be controlled for a relatively small outlay - for example, a single NYMEX unleaded gasoline contract covers 1,000 barrels, or 42,000 gallons -- even minor price movements can result in substantial account swings, causing nervous traders to abandon sound goals and strategies. While the potential for large gains in the futures markets is ever present, so too is the risk of loss, and therefore an honest assessment of risk tolerance is advisable before taking this particular plunge.

Aspiring energy traders who like the concept of futures but might not have the stomach for piloting a vessel whose slight turns of the wheel can result in such shifts of direction may want to ply the unleaded gasoline waters in a smaller, more nimble craft known as an emini futures contract. Fully electronic and trading virtually 24 hours per day, the emini unleaded gasoline contract features the attributes its name implies; it is an electronic version of the traditional unleaded gasoline futures contract. Emini unleaded gasoline contracts are identical to the full-fledged NYMEX contracts, except at half the size.

This miniaturization allows investors to enjoy the same liquidity and price transparency of the industry-standard NYMEX market but helps to limit the initial investment and inherent risk. The smaller capital requirement and risk exposure often results in a corresponding benefit for those new to the commodities markets as well, as trading decisions can be based on rational strategic assessments, without the anxiety and distractions associated with sizable equity swings.

Return to August 2006 Contents

Originally published in the August 2006 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved.
© Copyright 2006, Technical Analysis, Inc.