Coffee with Professional Commodity Trader (Part 1)

I recently met up with a professional commodities trader (NK) to talk about trading in general. We sat outside Starbucks and I enjoyed a Caramel Frappuccino in the sun for nearly two hours. Once I got through the whipped cream, I found the sun had melted the drink to liquid. 1-2 days later, I also regretted not having sat in the shade.

In any case, here are some miscellaneous notes about our conversation:

• NK believes the permanent portfolio (Harry Browne) is worth looking at with 25% allocated to cash.
• I was talking about potential benefits of time spreads and NK mentioned another (besides horizontal skew and weighted vega) that he couldn’t name or completely describe. This has something to do with IV getting cheaper as options move ITM (maybe involving the second or third derivative of IV).
• NK believes low IV makes options on GC and 6E prohibitive to sell.
• One thought about commodities that makes common sense is to go long (short) when term structure is in backwardation (contango) because price will then move in your favor over time.
• NK is a believer in LT trends for commodities.
• As trend followers, CTAs may have four good years followed by eight bad years, etc. The good years will far exceed the bad, and commodities are generally a good [e.g. inflation] hedge regardless.
• Another idea with commodities, which is probably something most CTAs (as trend followers) employ, is to go long (short) when price is above (below) the 200-SMA. They may get chopped up at times, but they should catch big trends and never incur catastrophic drawdowns.
• NK suggests watching for opportunities to sell options after limit moves when IV explodes because even if market directionally moves against the position, IV contraction may result in profit. He has seen cases where same-strike options in far-apart expirations have been priced equally due to term structure.
• Beware of wide bid/ask spreads on commodity options.
• NK sometimes trades futures options and other times the ETF (options?). He finds the pricing is different and may even be an arbitrage opportunity. As an example, ETF price based on options from the nearest two months of a futures market may not respond as expected if IV explodes in one of those two months (I forgot to ask at this juncture whether 60/40 tax treatment is a factor in making this decision).
• NK previously worked for a brokerage that messed up client PM at initial rollout causing them to blow out accounts.
• NK doesn’t personally trade with PM and didn’t know much about its calculation. He occasionally gets firmwide risk sheets and never realized why it’s broken down into categories between +/- 15% on market price.

I will continue next time.