There is a substantial risk of loss in trading futures and options.

Past performance is not indicative of future results

Lumber futures have gone parabolic, but that probably won’t last.

Lumber futures are in the midst of a historical rally on the heels of a surprisingly hot housing market. I doubt anybody predicted this in March of 2020 but the surprise element is likely what has been a driving force to the rally. Further, lumber futures are known for a lack of liquidity which can cause price moves to become exaggerated as motivated market participants panic.
Several years ago, when commodities traded in pits, I recall walking by the lumber pit on my first trip to the trading floor. I was shocked to witness the lumber pit was merely a few guys reading newspapers while waiting for orders to come in. Even with the advent of electronic execution, liquidity hasn’t improved much. The front-month contract, November, had traded less than three hundred futures contracts by mid-day. Not surprisingly, the option market is a ghost town leaving speculators and hedgers with few “options” to manage risk.

There is plenty of risk to be had in trading lumber futures. Each full point is worth $110, and we are seeing daily moves of $20 to $30 per board foot or $2,200 to $3,300 to a trader. Nevertheless, parabolic commodities rarely stay that way for long because the supply chain adjusts for market demand and high pricing. If you are looking to go long lumber, you have probably missed the boat. If you are looking to go short, you had better have nerves of steel and plenty of margin. A retest of $830.00 on the November contract is possible but a correction could see prices as deep as $550 to $500. To put this into perspective, a retest of $830.00 from here represents $11,000 to a trader and a fall to $550 would equate to nearly $20,000. On a side note, the September contract is trading above $900.00 but it is in the delivery and expiration process and should no longer be traded.

Because futures contracts expire, when looking at a weekly or monthly chart, what you see isn’t always what you get. This is because long-term charts must combine data from separate contract expiration months and that leaves some room for misinterpretation. For instance, the continuous weekly chart of natural gas I use for analysis is based on the front-month contract, which requires us to read between the lines. We have mapped out what we deem the comfort zone in natural gas pricing between $2.50 and $3.50; the front-month contract (October) has slightly entered the comfort zone but the back-months are in the middle-to-upper section of the zone. In short, the recent rally has put prices into what we have charted as the comfort zone and will likely see upside momentum wane sooner rather than later. We expect prices to dribble lower in the coming weeks.

Hypothetical trade idea:

Buy 1 December Natural Gas $3.25 put

Sell 2 December Natural Gas $3.00 put

Buy 1 December Natural Gas $2.75 put

Total Cost and Risk = 5 cents ($500)

Margin = 0

Max Profit of $2,000 occurs at expiration in 84 days if December natural gas is trading at $3.00, but the trade pays off something between $3.20 and $2.80.

COMMISSION ON FUTURES OPTIONS IS CHARGED PER CONTRACT. THUS, WHEN TRADING SPREADS, THERE IS A COMMISSION AND EXCHANGE FEE CHARGED ON EACH LEG OF THE SPREAD.