This post is non-stock related but I thought it would be cool to post a picture of my dog playing in the blizzard yesterday since snowfall totals can make investors money. How? I will explain that below!

Many of the readers of this blog come from other parts of the country and even other parts of the world. We received about 22” of snow in a 15 hour period. We did not set the snow record in my town as we are in the suburbs and have had storms reach 30” or more but it was the all-time record at 26”+ in NYC.

My wife named our dog Bob! I call him Buddy Bob or Bobby.

Since it did snow, I figured I would link this image of my dog playing in a lot of snow with something that many of you may not know:
Weather futures can be traded on the CME (Chicago Mercantile Exchange).

Inside of this world of weather futures, investors are now able to trade Snow Futures and Options as reported in the Chicago Tribune and Bloomberg News:

Chicago Merc to trade snow futures, options

By Darrell Hassler and Nandini Sukumar
Bloomberg News
Published February 9, 2006, 2:19 PM CST

The Chicago Mercantile Exchange, the biggest U.S. futures market, is creating futures and options contracts that pay out based on amount of snow that falls in New York’s Central Park and Boston’s Logan International Airport.

The Merc, the only exchange to offer weather derivatives, is expanding its range as trading surges in existing contracts linked to the number of frosty days and the temperature in U.S., European and Asian cities.

Weather derivatives trading at the Merc jumped more than sevenfold last year to 889,000 contracts on demand from companies whose fortunes change with the weather. The derivatives might be used by municipal snow removers or energy traders, said Brian O’Hearne, managing director of the environmental and commodity markets for Swiss Reinsurance Co.

“There really is an increasing interdependence of commodity price action and weather action,” O’Hearne said in an interview from his New York office. He is also president of the Washington- based Weather Risk Management Association, a trade group.

The derivatives will be based on a new snowfall index that the Merc will create, with contracts for each month from October through April, the Merc said in a memo to clients yesterday. Merc spokesman Allan Schoenberg confirmed the contents of the memo today.

The index will be based on the amount of snowfall in the designated month of the contract, as reported by Earth Satellite Corp. taking measurements at the Boston airport and New York park.

Futures are agreements to purchase contracts at a set date and time, while options give one side of the contract the right to do so. The contracts are settled only on the last day of each contract month, the Merc’s memo said.

Schoenberg declined to elaborate more on the contract.

The Merc’s shares fell $3.39 to $400.51 at 2:48 p.m. in New York Stock Exchange composite trading. Before today, they gained 92 percent in the past year.

-Piranha

MSW Member Question:

Hi Chris,
congrats on your TS calls. I wanted to know about how many contracts do you usually buy for a given stock,and how deep in the money do you buy them? (or do you buy them OTM?)

It seems like: Find a growth stock (60-100 or not) Buy ATM or ITM Calls for 6 months to 1 year out (Leaps). Wait for a decent point move and sell out I’ve bought a bunch of different Calls for different stocks, I have some on OXPS I bought on the drop and have had some on UPL for a while, but I only have 2 contracts each, not out of lack of funds but feeling I had to be diversified.

This however does not produce big returns for me when the stock moves. Should I be buying more contracts?

thanks for your input.

My Answer:
Good to hear from you!

I only bought 3 call options with (TS) because it was a risky play buying at the bottom of a base formation. The rule of thumb is to only buy as many call options as you would buy shares in the company. So, at $110, three call options controlled $30,000 in shares or 300 x $110. However, I do know option traders that buy many more shares than they could ever handle and do okay for themselves. I like to buy near the money or slightly in the money options. Occasionally I will buy out of the money options but I have had better results with the ladder. Options expiring six months to one year out are not leap contracts. Typically LEAP contracts are two years out from the current date. I rarely buy LEAP contracts.

In the case of Tenaris (TS), I thought out in my mind where the stock could realistically travel. Due to the cup shaped formation, $145 seemed like a very logical position for the pattern to form a handle so I set that as my target. I told myself I would sell when it passes this point. In this case it did, so I sold even thought I still had almost five months left in the contract. A 223% profit in two months is hard to debate when it meets my original objectives. When you start to get greedy and break original objectives, you typically lose money. I have had that happen too many times so I sold with asking questions.

Buy as many contracts as you feel comfortable with. Don’t worry about the overall profits at this point. Worry about the percentage gain you are achieving with each position. When you consistently make large gains, increase the size of your positions.

I am still learning to trade options so I don’t teach my methods just yet. I stick to what I know best: buying stocks making new highs, grabbing shares near support or moving averages and stocks breaking out from strong patterns.

Piranha

…Today I am going to feature a question I received from a member and how I answered this question. As you know, I answer questions all day long for members of this site.

E-mail Question:
Hello Chris,
I hope the Holiday was enjoyed by you and yours. I see MCO on the daily screen and am curious about long term options. As you know, I have AAPL options (both Jan 55 and April 55 calls) that move pretty much in unison with each other. Sometimes the April call actually goes up more than the January during the day. Actually I just missed selling the Jan. options at the top today and am watching them closely (60% profit). Anyway, how much does an option move that is a year out? I’ve learned my lesson and with options, I will NEVER hope that they will come back and let the loss get bigger than it should be which depends on how many contracts I have. 10 contracts and I can let it go down quite a bit (never more than 50%) but the 30 to 60 contracts that I’ve held at one time in APPL, not even close to that much of a loss! That’s why I asked about the signs of a correction coming but that’s for another day.

If you were to buy the long term call for MCO, how high would it have to run before the profit started building up? I’m thinking that far out, it wouldn’t move much for the first part of a run.
Bob

My Answer:
Bob,
I am going to use one example to explain this:
Say I buy the Jan 07 $55 call for $10.60 per contract (the asking quote this morning – 11/29/05, 9am).

This means that your break even point will be $65.60 (anywhere during the contract period minus fees and taxes). The break even point is always the call target ($55) plus the premium that you paid ($10.60 in this case).

If the stock moves to $80 in the next two months, the premium will be worth approximately $25 so you would have a profit of 150%. You would have this same profit if it took until next December to move to $80. For every dollar that the stock increases above $65.60, you can add a dollar to the premium you paid. I know time factors and volatility play a role in the actual premium price and the spread between the bid and the ask but the dollar approximation is a simple calculation that can give you a general idea of your potential profits at any time.

If the stock takes 8 months to move to $100, your call premium would be priced near $45 each (a $35 profit per contract or 350% profit). Remember, the breakeven is $65.60 so take $100-$65.60=$34.40 profit; add the original premium that you paid ($10.60) and you get the approximate price of the option contract at $100 = $45 ($34.40+$10.60).

You can have an immediate profit in a long term option if the stock price rises quickly above the breakeven area.

Although I do not teach options on this site, I am open to questions privately and will let you know if I am qualified to answer the question when it relates to options.
Thanks and Enjoy,
Piranha