Shorting Commodities

I’ve been writing a lot lately about lower stock prices ahead. I sold positions last month and am looking for a good price at which to get out of Ultra Semiconductor before summer.

I’m going to go one farther now and bet on those falling prices. Being in cash is a way to protect against declines. Shorting stocks or indexes is a way to profit from declines.

In this case, I’m targeting commodities. The financial press has been buzzing for the past two years about how China is eating up the world’s resources and about the coming war between America and China over oil. Jim Rogers, the famous international investor, even created his own commodities index and it has been a top performer. Oil is up, raw materials are up, everything needed for building seems to be up.

As you know by now, when things look rosy all around, they’re not. That’s why I began thinking about investing contrary to this long-term trend. For the record, I, too, believe that commodities represent a good long-term investment. But as I exited Sun and Maxtor and UTStarcom, I began looking elsewhere for trends and a short-term trend I found was that commodities appeared to be getting ahead of themselves. Then, yesterday, I received a note from my friend Dan Denning at Strategic Options Alert in which he suggested the same thing. I respect Dan’s judgement, and that note was the tipping point on this investment thesis. I decided to short commodities.

Dan feels, and so do I, that the best way to do so is to buy puts against the Materials Select Sector fund from Standard & Poor’s, symbol XLB. In the last two years, XLB has moved from $18 to $30. Take a look at the chart.

Puts are options that rise when the underlying security falls. Buying these puts is similar to shorting the index, except that options enable you to leverage more financial power with less money. I have not yet written a book about options and I rarely suggest options here. If you don’t know about them, please spend some time reading up before making any moves. If it’s too confusing, sit this one out. I’ll provide plenty of mutual fund and stock recommendations in the future.

I’ve placed a limit order to buy the XLB June $30 puts (XLBRD) at a price of $1.10. They’ve been bouncing between $1.10 and $1.25. I hope a quick spike down will give me the better price. If XLB falls to the high- or mid-20s by June 17, we’ll see a nice profit on these puts.

Remember, if you don’t understand options, then sit this one out.

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