by Lee Lowell, Stock and Commodity Option Specialist
Tuesday, October 13, 2009: Issue #1114

Anyone can buy a stock. But not everyone knows how to buy stocks at the prices they want and get paid instant cash for doing so.

But that’s exactly the strategy I showed you how to execute in my last column about the world’s commodities – one of the best ways to go long on stocks. It’s called put-option selling, where you receive money upfront in return for obligating yourself to buy shares of the underlying asset at the price you want.

In my example, I examined a hypothetical trade that involved a bullish play on gold – specifically, on the SPDR Gold Shares (NYSE: GLD) – an ETF that tracks the price of gold. I wanted to buy around $91, so I sold the December 2009 $91 put option (GLD-XM) for a limit sell price of $1.40 per contract.

At the time, GLD was trading around $97 per share. While regular stock buyers would wait for a pullback to the $91 area (which may or may not occur) before buying shares, smarter investors know they can sell the $91 put options and collect instant cash.

And it’s paid off…

The Profitable Put-Selling Advantage

Since then, GLD has risen to $103 on the back of record highs for gold prices. When stock prices go up, put-option prices go down, so the price of the December $91 put option has moved to $0.40 per contract, giving our hypothetical trade a paper profit of $100 per contract (or $1,000 if trading 10 contracts).

Here’s where selling put options comes in handy…

When you sell put-option contracts, you can look to buy them back cheaper as a form of turning a profit. This is something that a straight stock buyer cannot do, since they haven’t been able to enter the market at all. Chalk up one for the option trader!

So since GLD has gone up in price, we could either take profits now, or continue to wait until options expiration to see if the options will expire worthless. If that happens, we’d make the maximum profit on the options.

Now onto the current state of play in the commodities world…

Gold $2,000?

When I last profiled gold and silver on September 7, I noted how they were both poised to break through their yearly highs after a brief pullback.

They certainly haven’t disappointed.

Gold has regained the elusive $1,000 per ounce area and has motored to all-time highs of over $1,060 per ounce. With rumors swirling about the eventual demise of the U.S. dollar (due to the increasing debt load), gold could become the currency of choice. In fact, some analysts say it could shoot to $2,000 per ounce.

Silver Set to Follow Gold to All-Time Highs

Meantime, silver has rallied back to the $18 per ounce area – a new high for the year, but still $4 per ounce below its all-time high of $22 from February 2008. However, the way these markets are trading now, it’s probably only a matter of time before silver gets back up to those all-time highs.

For now, both gold and silver look very strong.

Let’s take a quick look at few other commodities making large moves lately…

Corn Bottoms Out and is Ready for a Weather-Induced Run

The corn market has finally come off the lows that it’s carved out since the highs of 2008. Prices bottomed out a few weeks ago just above the $3 per bushel level and have since moved up near $3.73 per ounce.

With colder, wetter weather sweeping through the corn belts of the Midwest and hampering the harvest, the focus has shifted to whether the crop size will be as large as predicted. Look for December 2009 corn futures to rally up to $3.90 per bushel as the next move.

A Tug-Of-War in the Natural Gas Market

Despite its continued spell in the doldrums, I’ve held a bullish outlook on natural gas for quite some time – and it could finally be coming to fruition.

With the large storage of underground supplies still swamping the market, it seems that all the fundamental news has now been priced in and traders are focusing on the cold winter ahead.

This has provided the impetus for natural gas to finally move off the lows it has logged since the highs of 2008. After bottoming near $3.500 per MMB/tu just a few weeks ago, natural gas has tacked on an impressive 1,500 points ($1.500) to rally back up to levels last seen in early August.

With short-term resistance just ahead (at the $5.000 per MMB/tu mark), we could see either a slight pullback, or a neutral move over the next few weeks.

The bulls and bears are currently waging a tug-of-war, with bears still citing the large supplies for a fall in price, while bulls believe winter could deplete the reserves.

Lastly, we move to the sugar market…

Sugar Set to Drop – and Drop Big

I profiled sugar as a potential shorting opportunity back in late August. At the time, it had carved out highs not seen in over 28 years, due to supply concerns in two of the world’s biggest sugar-producing nations – Brazil and India.

As with any market making new highs or lows, there comes a point where all the fundamental data gets factored into the market. It’s then a question of how long can those prices hold. For sugar, I believe the time has certainly come for the market to drop – and drop big.

In fact, the March 2010 sugar futures – the most actively traded contract – have already started to crack. If you want to play the downside, you could buy limited-risk put-option contracts for the March 2010 or May 2010 expiration periods. These contracts trade on the floor of the NYBOT/ICE exchange in New York City.

Good trading,

Lee Lowell

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