Gravity is finally taking hold of commodity prices. And it’s about time. The lot of them were flashing overbought readings. The overnight weakness in commodity futures translated into a gap lower for a host of related securities from energy and gas stocks to metal and mining names. Inflation trades, in other words.
This will be the beginning of a multi-day retracement if we’re lucky. If we’re unlucky, prices will rocket right back up, robbing us of a better buying opportunity.
Either way, an opportunity is knocking.
The connection between inflation-sensitive securities right now that I don’t think stock-picking matters all that much. That said, I do have my favorites based on their consistent price action and volatility characteristics. As an options seller, I’m always looking for cheap names with low collateral requirements for plays like naked puts. Here are three tempting targets:
Each offers slightly different exposure, so there is some diversification depending on if you’re looking for exposure to energy versus copper versus iron ore and steel.
Inflation Trades to Buy: Freeport-McMoRan (FCX)
This week copper prices jumped past $5 for the first time. The euphoria brought fresh buyers into Freeport-McMoRan, which many traders view as a copper proxy.
FCX stock topped $50 and has since quietly retreated to the rising 20-day moving average. We’re also retesting an old resistance zone near $45, and it’s holding as new support so far.
There are two ways to play the pullback using options. Aggressive traders can build call spreads that offer significant upside. Alternatively, selling puts or put spreads offer less reward but a far higher probability of profit. The higher volatility makes short puts my trade of choice, particularly if you’re a willing buyer of FCX into weakness.
The Trade: Sell the April $40 put for 90 cents.
Cleveland-Cliffs just polished off an eight-day run for the ages. Prices surged 40% in a straight line amid massive accumulation.
The Ohio-based iron ore and steel company is a favorite among momentum traders due to its ultra-cheap share price and volatility. Profits come quickly when you’re on the right side of its massive swings.
The first pullback since its explosion has arrived, and this is likely a buying opportunity. We’re still well off the 20-day moving average, so there’s a chance the retracement deepens before a sustainable bounce arrives. To provide ample room for prices to find a bottom, I’m again going with a short put play. The return on investment is too high to pass up.
Remember, selling puts obligates you to buy shares at a discount to the current price in exchange for getting paid a premium.
The Trade: Sell the April $20 puts for 65 cents.
Inflation Trades to Buy: Devon Energy (DVN)
Crude oil is the king of commodity pits, and it’s undoubtedly been demanding the most attention given the current state of the world. While terrible for consumers, oil prices north of $100 are a boon to corporate profits for energy companies. Investors know this and have been bidding stocks like DVN to the moon.
Today’s drop pulled prices back to the rising 20-day moving average. Previous dips have provided lucrative entry points for new bullish trades, and I suspect this will prove no different. Let’s switch things up and build a more directional play.
The Trade: Buy the May $60/$65 bull call spread for $1.70.
You’re risking $1.70 to make $3.30 if DVN rises beyond $65 by expiration.
On the date of publication, Tyler Craig did not have (either directly or indirectly) any positions in the securities mentioned in this article.