 Hello everybody. Welcome to this webinar hosted by Tickbill and CME Group. We're going to begin in just a minute leading off with my colleague Eric Norlin. He's going to join us here in just a second and he will begin today's webinar and I will follow up in the second half with a few educational pointers a little bit more specific to the options business. Welcome back Eric. Ready to begin? Yes indeed. I am almost ready to begin. Yeah absolutely. Just give me one second. I just you know interest rates have been moving so quickly. I was literally just updating a graph on my presentation right now so that it would still be relevant. So yes here we go. So let's begin with the economics discussion. There is a tremendous amount going on to kind of bring this to light. I'm going to share a slide deck with you. Just give me one second here. I think that this is it. Yes here we go. Now let me share this and David are you seeing this okay? I'm going to put in slideshow mode. Certainly am. Full screen. Okay yeah one second. There we go slideshow mode. Thank you. Yeah so tremendous amount happening that is impacting you know commodity markets as well as financial markets and the two markets as we'll discuss are very very deeply interconnected. The last time that David and I spoke with you in February we focused mainly on financial markets and so the topic this time is commodities and inflation. Well inflation unfortunately is still very much with us. A few hours ago at 1 30 in the or 12 30 actually in the afternoon London time or 1 30 p.m. on the continent we got the US CPI number the consumer price inflation number and that number came out pretty close to consensus but it still showed six percent headline inflation and five and a half percent core inflation including a one half percent increase in core prices in the United States just for the month of February alone. We also got European inflation out earlier this month. Europe releases its inflation numbers very quickly. They came out I think on the 1st or 2nd of March and it showed that core inflation in the Euro area rose to 5.6 percent its fastest pace since Euro stat began collecting continent wide or currency wide data for the Euro zone and so all of this is having a big impact on commodity markets but it may not be the impact that you think before we get into the heart of the presentation I do have to show you both the short version of our disclaimer which basically says that we are an exchange operator and cannot provide you with any financial advice so no financial advice is given or intended and a longer disclaimer that explains how we are regulated in various markets including in various markets throughout the Euro area and throughout the European Union and in this close neighbors like in Dubai and in the United Kingdom so with that in mind we can begin with this topic of inflation and I think most investors have this very simple model in their minds that inflation is good for commodities so if inflation goes up commodities should go up too but it turns out that reality is more complicated than that and inflation is not necessarily good for commodities but I think that maybe the best place to begin this discussion is with gold because gold is often presented to investors as an inflation hedge and it might be an inflation hedge and we'll we'll talk about that the one thing that's very noticeable here is on the left-hand chart we saw low and stable rates of inflation from 1998 until 2020 we do typically around 2% inflation in the U.S. Europe the UK and then suddenly we had this massive surge in inflation you know from 2% up towards you know six to ten percent depending on the country and which monthly we're looking at the the data in you know meanwhile gold hasn't really done what you might have expected I mean first of all I don't show it in the chart but gold prices back in 1998 were around two hundred and eighty dollars an ounce by 2011 they had risen from two hundred and eighty to two thousand dollars an ounce or nearly two thousand an ounce you had this huge run-up in gold prices despite the fact of having had low and stable consumer price inflation you know then you know in the most recent period gold prices in the last two and a half years haven't done anything you know the gold price of gold in the summer of 2020 got to around two thousand dollars an ounce and for the last two years and nine months it's gone sideways despite this huge huge surge in inflation so I think a lot of investors are asking themselves why did gold not hedge inflation you know or did gold head inflation hedge inflation in a way that we maybe don't quite understand so it turns out the reality is more complicated you know gold moves pretty independently of inflation I think for one simple reason which is a gold is basically a currency but it's a currency that pays no interest it's a zero interest currency so if you own gold you don't get any you don't get any money for your gold deposits by contrast if you take your fiat currency whether it's euros or pounds or dollars and you put it in a bank sometimes the bank will pay you interest in fact usually banks pay interest on deposits it was really only in a period from 2008 to 2022 when interest rates were set close to zero for most of that period the bank stops paying interest on deposits so it turns out the gold has a very strongly negative correlation with expectations for interest rates in the future so in his left hand charts we have the Fed funds future forward two years so in other words the interest rate market view about where the Federal Reserve is most likely to have policy in two years time in the black line and then you have the price of gold in the blue line so what you can see is that there's somewhat of a negative relationship when investors think the Federal Reserve is likely to begin raising rates in the next two years the price of gold usually falls you know that was the case for much of the period from 2014 to 2018 when the market anticipated that the Fed was going to start raising rates which it eventually did that wasn't very good news for gold but then gold had this massive rally but the massive rally didn't happen with inflation happening in 2021 and 2022 and 2023 the rally in gold happened from the beginning of 2019 to the middle of 2020 so why did that happen well it happened because the Federal Reserve was expected to slash interest rates and indeed did slash interest rates a cut interest rates from two and three eighth percent down to down to zero and this is the graph I was updating actually just a second ago because I know we've had this huge huge move in gold prices in the last few days and so yeah then the price of gold gets up to two thousand dollars an ounce and then it doesn't go anywhere so why well on the one hand inflation is pulling gold higher yeah so the dollar the euro the pound all of these fiat currencies issued by central banks are now losing value versus commodities so that's causing gold prices to stay up but on the other hand because of all the inflation the market now expects the Federal Reserve and other central banks to be in tightening policy so there's policy expectations started to form a little bit in 2020 and through the first half of 2021 but they really started accelerating in the second half of 2021 and into the middle of 2022 and you can see gold took a pretty big drop it fell from two thousand fifty dollars an ounce down to around sixteen hundred dollars an ounce it had a four hundred dollar drop in the price of gold despite high inflation but over the last few months markets have started to change their views of what the Fed is going to do and those views have been changing sometimes very rapidly last fall for example the market started saying okay the Fed can't really raise rates that much they're gonna have to start cutting gold love that it rebounded from sixteen hundred to nineteen hundred dollars an ounce then yeah we got some really strong numbers for employment growth and for inflation in late January and in February so the market started repricing the Fed was gonna maybe hike a bit more what happened gold prices fell and then in the last couple of days we had the collapse of Silicon Valley Bank which is the first real casualty of the Fed's interest rate hikes so in the last few days we've seen a 100 basis point deep pricing of Fed rates as a result of that gold prices had some pretty nice days there up a couple percent on Friday up three percent yesterday silver which is a sort of like a high beta version of gold is up six percent yesterday silver and gold are very highly correlated metals but on the right hand side you can see the one thing that is very consistent for silver and gold is that they have a negative correlation with changes in expectations of future Fed rates and so they really really don't like higher rates but I think that what happened yesterday is very very interesting for gold and silver and for other commodities as well as for interest rates and for equities because it highlights the dilemma that central banks are in you know I'm based in London in the United Kingdom in the United Kingdom the central bank here has raised interest rates up to four percent but something here really strange happened last fall the Prime Minister at the time the very briefly serving Liz trust who lasted seven weeks in office proposed massive supply-side tax cuts as a result the bond market started to sell off so the guilt market the 10-year UK Treasury bond rose from 3% to 5% yield and as they did that it forced the central bank here into a dilemma either they could fight inflation by raising interest rates or they could favor financial stability by intervening in the guilt market and printing 75 billion pounds to buy guilt the central bank here chose to intervene in favor of financial stability we haven't seen something like that happen yet in the Euro area but over and over in Europe the European Central Bank is widely expected to raise interest rates 15 more basis points when they meet on two days from now on Thursday this week despite all these rate hikes these central banks have interest rates far far below the level of inflation you know here in Europe we have interest rates roughly 220 basis points below the level of core inflation you know and in the United States it's a similar story in the United States the Federal Reserve despite having done the biggest rate hike since 1981 raising interest rates 450 basis points and counting it still has its policy rate over a percent below core inflation and so this to my mind is really really shocking and it really indicates that the Federal Reserve is also now in a dilemma they can either continue to raise interest rates as a fight inflation in which case they risk being more bank failures like we saw as Silicon Valley Bank more financial instability or they can maybe stop raising interest rates to help the banking system adjust to the higher rate environment and then just maybe not fight inflation is hard and allow inflation to stay higher for longer so all central banks are now being faced with this choice between financial stability and fighting inflation and this choice I think is very very good for gold because no matter what the central bank chooses it's likely to be good for gold if the central bank chooses financial stability then in that case that means they're going to stop raising rates that could be positive for gold and for silver on the other hand if they choose to keep raising rates that might be bad for gold and silver in the short term but it could cause more financial instability in the long term which means at some point in the future the Federal Reserve or the ECB might have to dramatically cut interest rates if we have a recession and that's basically what the financial markets are positioned for if you look at the yield curve in the US short term interest rates are now much much higher than long term interest rates you have an inversion of the US yield curve and yield curve is a very good indicator of where the economy is going in perhaps 12 to 24 months time so US you know people are saying well look we've raised interest rates now and there's still no recession and companies are so hiring etc that's true but that's because there's a long lag between when the central bank moves policy and when it impacts the economy so all these Fed rate hikes all the ECB rate hikes etc I think are going to show up in the economic data sometime later this year and next year we're going to see a big slowdown in Europe a lot of financial instability in Europe a lot of financial instability in the US private sector also really tough budget choices in Washington with possible government shutdowns or defaults on debt all of which damages the credibility of fiat currencies the market for its part is pricing that the Federal Reserve will raise rates so maybe two more times but then the market thinks the Fed's going to start cutting rates probably later this year and through next year and see if that happens that could be really really good for gold so we've been talking a lot about gold gold is not the only commodity out there of course it's influenced by inflation you know a lot of people also ask the question well how are crop prices like the prices of corn wheat and soybeans influenced by inflation and here too the answer is more complicated than you might imagine you know a lot of people have sort of distant memories or perhaps no memory of the 1970s probably think that higher inflation in the 70s was good for crop prices the truth is it was more complicated we had a big surge in inflation and through 1968 to 1970 and crop prices did not really go anywhere then we had a second huge surge in inflation in 1973 and 1974 and that time crop prices rocketed corn prices went from 100 to 400 cents per bushel so the price went up 300 percent I would then we had a last even bigger surge in inflation at the end of the 70s until 1980 in that time corn prices you know had fallen in a mean time to run 200 they rose back to 400 but they didn't really get to a new record high and then we had a long long period of disinflation in the 1980s and 1990s and during this time for the most part corn prices just went sideways in a wide range but farmers you know really suffered during this period but then you know much like gold corn prices soared during the decade from 2000 to 2011 even though we did not really have much consumer price inflation overall so what was happening at this time is that natural resource prices were rising but wages weren't rising the cost of employing people wasn't rising productivity was growing very quickly so there was just not a lot of inflation now this time around we have seen a surge in corn and other commodity prices as inflation has risen but that's rise hasn't been maybe as pronounced as you might imagine but a lot of it I think has also been driven by what happened between Russia and Ukraine as well it's a very similar story if you like it soybean for example soybean showed no reaction to the inflation in the late 1960s then they went at a tremendous rally they went from 300 to 1200 cents per bushel in 1973 it then later on in the 70s we had even higher inflation I'm eventually getting to 14% under the Carter administration at the end of the 70s soybean prices didn't do particularly well and soybean prices basically didn't really do anything again until around 2005 when soybean prices soared to then new record highs despite the fact that inflation overall really wasn't that high but this time around ag prices have gone higher with inflation so it's kind of hit or miss sometimes corn and soybean prices respond to inflation and sometimes they don't and of course it's the same story we you know again no response to the rise in inflation at the end of the 60s but then a huge response in the early 70s the early 70s rise by the way had a lot to do with buying from the Soviet Union which came into the American markets and bought tremendous amounts of corn wheat and soybeans during this time that had a big big impact what was referred to in the markets is the great Soviet grain heist but not a lot of reaction in wheat prices to subsequent inflation in the later 70s but then again a huge rise in wheat prices from 2002 to 2008 even though inflation really wasn't all that bad so this time ag prices and inflation have both surged together but it's not a guarantee that they'll continue to move together in the future in fact if you take agricultural goods prices and you adjust them for inflation this is the graph you see so this is the prices of corn soybeans and wheat divided by the U.S. consumer price index cumulative index and what do you see I think is quite remarkable since 1965 crop prices in real terms have fallen in half so since 1965 we've had about a thousand percent inflation but food prices have only got up maybe five times instead of you know one ten times over like we've seen with other non-food products and this I think is truly truly remarkable because since 1965 the global population is more than doubled we've gone from three and a half billion to nearly eight billion people at the same time on average people eat better you know around the world people eat 50% more calories you might even argue that in many countries like the United States and Europe people eat too many calories but in any case people are better fed now than they were 60 years ago and crop prices have dropped in half in real terms so this thing is truly remarkable and it's a reflection of the fact that we've seen so much innovation in the farm sector we've had a revolution of agricultural productivity that what is interesting here there was in the last five or six years that productivity seems to have hit a wall we have not seen per acre productivity for corn wheat and soybean to grow since 2016 the reasons for that are not entirely known but there are some people who think this may have to do with climate change or global warming that as the climate's changing it's harder for farmers to continue to expand the amount of production that they get per acre per hectare that they've harvested you know talking about agricultural goods market to think it's a good transition into talking about other things that also influence acts and so one of those big influences is what's happening in China and so during the COVID period China has had a very very different response to COVID than has the rest of the world in the United States for example and in the UK and throughout most of Western Europe governments spent tremendous amounts of money to help people get through lockdowns so governments use this as an excuse to provide a tremendous amount of fiscal stimulus in the United States the fiscal stimulus came to 25% of GDP and I think that this is the thing that is primarily responsible for the rise in inflation in Europe and in North America and so you know a lot of people blame things like supply lines and yes supply line problems and supply chain problems certainly played some role in inflation but I think that those supply chain problems occurred primarily as a result of government spending if government in the United States in particular sent trillions of dollars worth of checks to Americans all over the country even people who did not need the help got paid as it was a result American consumers spending rose tremendously and it outstripped the ability of the US economy to supply goods and this was really bullish by the way for industrial metals like copper and aluminum by contrast China did not really spend much money on COVID-aid only 3% of GDP which is weird because they spent a lot longer in lockdowns but they eventually just made their population suffer without any help from the government and so in some ways you may say that's cruel but on the other hand China also has much lower inflation so China's inflation right now is around 2% compared to 6% in the UK or 5% in Korea 4% in Japan 6% here in Europe but what's happening in the Chinese economy is I think the single biggest influence on commodity prices especially the prices of energy goods like crude oil like West Texas Intermediate or WTI crude also a huge huge impact on agricultural goods and on industrial metals and so but the way in which China impacts these markets is sometimes not well understood I think everybody believes correctly that if China grows more quickly commodity prices should go higher and if China slows down commodity prices should fall and that's true but there's one additional complication and the additional complication is that when China's growth rate changes the impact on commodity prices often doesn't happen for a long time often about one year so why is that well a lot of countries store up commodities I'll give you an example the United States since the Arab oil embargo in 1973 and the Iranian Revolution in 1978 and 79 concluded that having a lot of oil and storage was important for national security so just in case our supplies got cut off so the United States established the SPR the strategic petroleum reserve where it essentially stocked hundreds of millions of barrels it would be enough to supply the US economy for months on end and more importantly to supply the US military for a long period of time if it became necessary China does the same thing but they don't do it just with oil they do it's pretty much all commodities so when you look at accelerations in Chinese growth you can see that for example in the blue line of our proxy for GDP called the Li Ka-ching index it accelerated in 2005 six and seven China was growing at a faster and faster pace oil prices rose and peaked in 2008 by that time China's economy was already slowing down very drastically and they had a really big slowdown in late 2008 and early 2009 and then the price of oil subsequently crashed from 140 to around $35 for barrel then China did a mega stimulus of its economy where they got the economy growing instead of four percent up to around 25% growth rates by 2010 oil prices soared and they eventually peaked in 2011 and they remained high for many years but in the meantime in 2011 2012 2013 2014 China's economy growth rate was declining and then very abruptly at the end of 2014 and 2015 oil prices crashed and went from 100 eventually down to $23 for barrel but in China stimulated its economy things started growing faster and oil prices later recovered then China slowed again going into the pandemic and oil prices fell then China because they reopened more quickly than most other countries did thinking they had COVID under control which turned out not to be true but nevertheless what they thought kind of the economy started growing very quickly in late 2020 and early 2021 the oil prices roared and they soared into the middle of 2022 but by that time China's economy had slowed down very dramatically and so now oil prices are starting to come back down and so China stores up about a one year supply of oil so you know if China's economy starts to accelerate this year which I think it will because they've lifted all of the COVID restrictions they've also eased their crackdown on property developers if I'm right in China's economy starts growing this year that may eventually be good for oil prices but it doesn't mean it will be good in the short term because China has a lot of oil and storage they don't necessarily have to buy more immediately if their economy starts to improve the same thing is true for corn China stores up a tremendous amount of corn I'd say probably in nine months to 12 months supply of corn or it's just housed in you know in in in you know grain storage facilities in China and the price of corn also tends to follow what's happening with Chinese growth but within even longer lag of often five or six quarters so in other words 15 or 18 months the same thing happens for wheat wheat also follows what's happening in China but again with a lag of four to six quarters so maybe 12 to 18 months later China at the moment is storing up almost a one-year supply of wheat so if their economy starts accelerating and oil prices rise they don't necessarily have to buy more repeats immediately finally soybean oil is also very closely connected to the Chinese economy it seems like soybean oil often follows what's happening with China's growth rate but about 12 months later so if you want a good indicator where agricultural goods markets might be going look at the Chinese economic data and especially look at the Li Ka Cheng index the Li Ka Cheng index is a combination of three things electrical consumption rail freight volumes and the number of bank loans so they're all hard things that are hard for the Chinese government the fake so they're actually you know kind of real solid pieces of data about the health of China's industrial economy yeah meanwhile China's reopening from COVID is great news but it's not the only thing that's happening in China the other big thing happening in China is that they have tremendous amounts of debt so in a short term reopening from COVID may create a surge in growth we hope but longer term China's economy still has a lot of problems and we talked about China's mega surge in growth back in 2009 and in 2010 that you know contributed to a huge rise in commodity prices but that surge in growth was fueled by rising levels of debt they basically told their companies to borrow money and to invest in infrastructure products projects and that sent the price of oil the price of copper and aluminum etc. soaring since then however China's debt levels have gone from low levels to levels that now exceed those of the US and Western Europe so this along with the fact that China's population is no longer growing is a large part of the reason why we think that China's economic growth over the next decade will not be particularly strong China also has a very large property sector the property sector a real estate sector in China comes to nearly 30% of GDP and we think that's too big Xi Jinping began to crack down on the property sector a couple of years ago that's another part of the reason in addition to the COVID lockdowns what China's economy grew so slowly last year Xi Jinping has been easing up on the property developers so she's seen this recovery for example in Chinese high yield bond prices an indication that things in China are easing up a bit but those markets are still very very far down from their peaks and so property markets continue not to do well it's not clear that China's economy can support higher commodity prices you know lastly there's the issue of China's currency China's currency generally over the last few years has been weakening versus the U.S. dollar part of the reason for this is that while the U.S. Central Bank is raising interest rates China Central Bank has been cutting interest rates and so as a result the when men be has been weakening or the you on has been weakening so all of these things I think are things to look at just a few other items here when it takes you know one other important thing anybody in our commodity markets needs to consider is the shape of the forward curve the forward curve tells you where investors think prices will be in the future most likely be in the future so for example if you think soybean prices and corn prices are going down you can't necessarily make money in those markets by taking a short position because the term structure of those markets already reflects an expectation of lower prices for corn and soybeans the wheat market here is different we just still very disturbed by Russia's invasion of Ukraine and traders think there's going to be a lot of tension in the wheat market over the next few years likewise corn or soybean oil and soybean meal prices are also in what we call backwardation the short-term prices are higher and prices further out on the curve because traders expect those prices to fall another thing to consider agricultural goods prices are very tightly connected with energy prices you may have wondered why ag prices react to what happens in China a lot of it has to do with the fact that ag and oil prices are tightly connected for two reasons first agriculture is energy intensive it takes a lot of energy to farm secondly biofuels corn and soybean oil in particular are often used as additives to fuels and to refine products so when you look at the oil market the oil market is also in backwardation traders in that market think that most likely West Texas intermediate crude oil prices will fall from around 80 to around $70 per barrel over the next decade or the next I should say three two years or so part of this is because we've seen a tremendous rise in oil inventories the oil market is very well supplied at the moment we have a lot of oil and inventory it's higher now at the end of February than it was at similar times of the year in 2020 2019 2021 or 2022 it's a little bit of a different story for products like gasoline and ultra low sulfur diesel formerly known as heating oil their inventories are not as high but we have seen of a recovery in US production OPEC has been trying to keep a lid on prices but they haven't really been so successful so with that in mind I'm going to pass the baton over to my colleague David who can share some additional ideas on how you can execute trades in the commodity markets from a technical perspective based upon your own insights into those markets thank you Eric I'm going to like yourself share a screen presentation deck bear with me just a minute let me know if you can see that is my my deck up on the on the screen yes it looks good okay then let's begin thank you Eric for that wonderful introduction on the commodity markets relative to inflation and what a great time to be having this conversation with what's been going on in the world capital markets in the last just just several last couple of days it reintroduces the concepts of pricing volatility and that's going to be a subject that's going to be at the heart of what I'm about to present so like my colleague I'm going to be to begin by saying today's session is meant to be educational and informative and is in no way meant to be construed as offering investment advice nor making trading recommendations you're going to see examples of some trading strategies in the next couple of minutes but they should not be taken as investment advice nor as recommendations on trades that are merely being used to demonstrate for educational purposes the futures markets of which CME group is a large part of have as their historical tool standardized futures contracts and futures contracts have been marvelous for commercial and institutional hedging for many many generations in that they allow commercial and institutional users of our markets that already have the business risk of being in the physical commodities to use the futures contracts as a hedging or a risk management tool and what makes these contracts useful to them is that they have a linear reaction to the underlying prices in other words if you're long a futures position to either replicate risk or to lay off the the impact of of higher prices and those prices do go up the futures contracts go up with them in a linear relationship if you're using the futures markets from the short side are selling futures contracts and anticipation of lower rates or as a hedge against lower commodity prices they're also hugely beneficial but the relationship is rather linear in terms of reactions to prices what I'm going to suggest we look at today are options as a strategic trading tool or a risk management tool and one of their benefits and when you if you're familiar with options you know that there are two types of options calls representing risk to an underlying long position and puts representing risk to a short position long options positions in this case a long call like a futures contract benefit in a theoretically unlimited reaction to higher prices in other words if I'm long a call and the price of my underlying product goes up I'm going to have be able to participate favorably in that upward price movement but if I'm long that call and the markets go down unlike a futures position that has unlimited exposure to the price action a long call position has limited price exposure in the negative price action so if we consider a long put position it benefits theoretically to unlimited means to a market price lower action in the marketplace where if the underlying commodity were to go up in price its loss is limited to the premium paid on a long put position this relationship in terms of options long options positions is said to be asymmetrical in that there are asymmetrical risk reward relationships to these long options positions this can make them in many cases wonderful trading and risk management tools another aspect of options as opposed to futures is part of their price input worth the inputs that go into the premium of the options themselves is attributable to market volatility which means that as market volatility goes up the premiums tends to expand in options as market volatility goes down the premiums tend to contract both puts and calls but this means that in many cases they can be used to either trade or hedge market volatility risk now I want to remind everybody that options premiums are driven by theoretical pricing models and because these are different depending on the system that you use or the options theory that you follow we can't always assume that we're going to get the proper results that we want so use options pricing and options tools at your own risk just a couple of reviews on options options can because of this a symmetrical risk reward relationship can be used both for hedging and for trading strategies they may be used in conjunction or as a complement to an underlying futures position as we're going to consider in the next few minutes but they also could be used against spot or physical risk positions as well now when we talk about options at CME group we're always referring to options on futures positions so if you want it rather than the underlying product so if you think about options at CME group you want to be thinking of them as a second derivative the first derivative being the futures contract that derives its value from an underlying physical or an index market the options at CME will always have as their underlying a futures position which means that they're deriving their prices from the derived first derivative which is the futures contract now not all of the options expirations at CME line up necessarily with their underlying futures market expirations as well so there's a certain amount of education that has to be done to get familiar with options at CME which options those are which futures contracts those options price to and what their expiration calendars are like relative to the futures contracts now when you purchase options you pay the full premium amount that is generally all that would be required to keep that position open because that's the maximum that that position can lose but in the event that you're either in spreads where you might result in a credit position or just short but options position since there is theoretically unlimited risk to that position there could be initial margining over and above the premium that's received required from CME clearing and for this you'll need to consult with your FCM or futures broker so options premiums are affected by lots of independent market forces the movement of the underlying futures contract the volatility of that price action as well as the amount of time left in the option itself options contracts have expiration dates just like futures contracts and that expiration date has an impact on the pricing of the premium understanding those different input variables and we sometimes refer to them as the Greeks delta and gamma reflecting market price action in the underlying's impact on premium Vega representing the impact of market volatility on the premium and theta representing the premium sensitivity to changes in time decay all go into the option premium pricing dynamics and if you need a little bit more education on options theory we have some curriculum and educational modules at CME Institute our teaching a portal on our website that can provide you some wonderful examples of education in this area that are free for your use we're going to consider in some working examples long and short or spread positions in options and so it is the net deltas and net gammas that we're going to be considered a net positive delta position is traditionally viewed as being a price bullish or have an upward bullish bias a negative net delta position would be viewed as a price bearish or downward bias to price a net long Vega infers up that the position would benefit from higher volatility bias and a short Vega or a negative Vega position a lower volatility bias and then long or positive theta represents the benefits of time decay whereas a negative theta position net theta position will reflect a cost of time decay being negative to the position Eric gave us a very good introduction on core excuse me on gold as a commodity market and I'm going to be using gold as a working example of how options on gold at CME might be used as a trading vehicle or a risk management tool and what you're looking at in this slide is a screenshot from a wonderful tool at CME group comm called quick strike and quick strike takes into account the pricing of options at CME group and what you're seeing is a picture of the gold market from the 2nd of March just a couple of weeks ago and the the blue line with the circles which is in some areas in this chart somewhat obscured by the purple line because the price action from the first week of March and the third week or the last week of February were very very highly correlated but you can see if you look at the green line at the top where prices were at the end of January gold fell rather nicely in the month of February and into the first week of March it has subsequently in the last several days rallied back pretty much or very very closely to that green line as prices existed at the end of January and you can see if you look at the x-axis at the bottom the location of the various forward expiration dates of gold futures contracts at CME so you're looking at a market that is said to be in Cantango where the price action of the deferred months are higher than the prices in the nearby months the slope in of that relationship is very dynamic it's different depending on a commodity it could be different depending on the seasonality of that commodity or also what's going on in that physical marketplace as it relates to expectations as expressed in the futures market but what we want to consider is that there's lots of gold contracts that have open interest and trading activity and the choice and the selection of that particular expiration month is that the discretion of the market user depending on what the risk is that they want to trade or hedge we list options on the various futures contracts that relate to the same expiration calendar here another consideration when we look at options is what's known as the volatility skew if you look at the relative volatilities of strikes relative to a particular expiration cycle you're going to get depending on the commodity or the market conditions something that may look like what you're looking at here this is the volatility skew of gold again on that that first week of March where the at the monies are roughly 1850 and you can see that that's where the lowest levels of volatility are if you go out in strikes away from the money either into the money or out the money you're seeing increases in the implied volatility of the strikes at those distant further away from the at the money strikes this creates what's known as a volatility smile and it's reflected in the shape of the skew chart in depending on market conditions you can see a smile that's very clearly defined here with the volatilities going up as you move away from at the money some commodities don't necessarily have a smile they might be somewhat skewed like in in equity index futures it's said to be more of a smirk because the the elevation in volatilities appears more dramatically in the out of the money puts that it does or lower strikes than it does in higher strike out of the money higher price strikes so different commodities have different volatility skews different times of the year can affect volatility skews but what's important is we look at gold at least in the next few couple of examples is as you move away from at the money volatility tends to rise and that can provide some benefits to risk managers and traders in terms of the application of various option related strategies I've created a table from quick strike data in this case again that that first week of March on gold when the underlying June gold futures was approximately 1839 even in terms of its price we're considering June expirations of options as well and what we're looking at are the if you look at the center of the table the 1840 strike would be considered the at the money strike and you can see if you move to the left columns you're looking at call information and to the right put information and because of put call parity the gammas the Vegas and the Thetas are the same for both puts and calls the various strikes and at the far left you can see the respective volatilities so if we look it kind of a reminder of that skew chart if you look at the volatility on the 1840s it's the lowest and as you move both in terms of higher strikes going down the volatility goes up and if you go to lower strikes and go higher the volatility also goes higher so it just reinforces that idea that as you move in either direction from the at the monies the volatility will tend to be higher in in its valuation which impacts the price or the premium of the options at those various strike prices we don't have the time to go into a deeper dive on options theory here but if you're looking for more information I would again refer you to CME Institute's curriculum on the options now we want to consider a couple of ways in which if we assume that an individual trader or a risk manager is already long gold and that gold could be in a physical position but in my examples I'm going to use a long futures position what would one might do to hedge or reduce the risk of an adverse price move lower in gold so if we assume we're already long the gold futures market our concern is to lower prices there are several options strategies that might be applied as opposed to liquidating the futures position which would of course eliminate the risk completely if I wanted to remain long my futures position in gold but wanted some protection what might I do in terms of options strategies to provide that protection well the oldest and probably the simplest options strategy is what's known as a buy right I'm already long the gold so I've already bought it and I'm going to short or right is another way of expressing a selling or a short position in an options position I'm going to write and and out of the money call to protect myself if we assume that the gold futures for June delivery are at 1839 even and the at the money volatility is at 1335 percent I want to be able to protect myself from a small downward price movement but maintain exposure to an upside price movement in other words continue to participate profitably if gold goes up but also get some downside price protection if the market were to sell off how do I do that well if we look at the delta of an 1819 30 call which is higher in its strike price than the at the money you'll notice it's got a higher price that in Delta at that higher price is roughly 23 I want to construct what's considered to be a delta neutral or a lower delta position in my outright long position by selling one 1930 call that has a Delta of 23 since I'm selling it it applies in my formula as a negative number which means it subtracts from my Delta of 100 because my futures position will always have a Delta of one so if I'm long one June contract I have a theoretical long Delta of 100 by selling this out of the money call I'm reducing my net Delta to 77 23 minus 100 that results in a credit because I'm selling the option I receive the premium on that option in this case it's worth $15 and 40 cents and each one of those is worth a hundred a hundred equivalent Troy ounces of gold I would receive roughly $1500 as as as a premium now that has to stay at the clearinghouse to protect the open position but it gives me some downside price protection in other words if gold were to sell off I would be protected to the level at which that $1500 and 40 cents $1540 credit is worth in other words down to 1823 60 as a June futures price so if gold goes down from 1839 to roughly 1823 60 I'm still going to maintain a positive P&L to the extent that I've received that that premium on that option now we can look at this graphically and this is another wonderful benefit of the quick strike tool it's available on see me group calm you can see that I've got somewhat of a limited price protection down to that level of 1823 60 beyond that I'm afraid I'm still exposed to unlimited price list but if the market were to rally I don't begin to flatten out until we get above 1945 and 40 cents so I will participate continue to participate in a upward trading gold market I will have a limited price downward protection to the extent of the premium that I've received in this by right strategy but beyond that still exposed to maximum loss so this is a simple example of a limited downside price protection provided by doing what's known as a buy right or selling a call against an open long futures position what if we want additional protection and perhaps participate by being long some volatility well you could certainly just go out and buy and out of the money put but that exposes you to an enormous amount of time decay risk another strategy using both long and short puts is called a vertical put spread and that's what we're going to consider next again let's assume we're long one June gold position at 1839 that long position has a delta of 100 per contract we're going to consider what's known as a long put spread and that involves buying a near to the money put and selling a further out of the money or down lower price strike price put in a one to one ratio and what that gives us is the long put protection of the nearer to the out of the money put the 1810 in this case which has a delta of 39 and since it's a put and we're buying it it provides a negative input in our formula and then the further out of the money put in this case the 1750 puts would also have a negative delta as a put because we're selling it it's applied as a positive number so the combination of the two results in a net delta of less than 100 so we're less long by putting on this vertical put spread but still long which means if prices go higher we're going to continue to participate in that upward profit activity if prices in gold go above 1839 but if prices go down we'll also have some price protection it's the position is pretty much neutral to gamma which means the speed at which the price moves is not very important to us the long net Vega means that if volatility increases it should favorably improve the price action of the spread but the negative theta tells us that time decay is going to be eating away at our adverse price protection so how does this look graphically well if prices trade higher we're going to continue to participate because it's a long put vertical it's going to give us some downside price protection but only to a certain degree and you can see that once you get down to the 1750 strike price the lower of the two it begins to lose its value and we will continue to have theoretically unlimited downside risk to our long futures position but we're going to participate in both the upward price action should the market trade higher once we've covered the cost of the spread and we've got some limited price protection at the downside but only to the degree of the lower strike price minus what we've paid for the spread so this again it provides some risk loss price protection to downside moves while allowing us to participate in upside moves but to a limited degree the last strategy we want to consider is known as a collar and it's called a collar because it wraps around both the puts and calls so well again we're going to start with that long June gold position at 1839 and a delta 100 and a collar involves the purchase of a put for that extreme adverse downside price protection and you can see it's at about a hundred points below the marketplace here as a 1750 put and we're going to help finance that insurance policy or that long put position by selling an out-of-the-money call and this is way out of the money at 1930 a hundred points above the market so you're receiving premium by selling the call paying premium by buying the put and because of the pricing of these two strike prices we end up with a much much lower net delta of 50 but yet it's still positive so if the market trades sharply higher we're going to continue to benefit from higher prices but we will also have some downside price protection in the event that the market sells off the gammas the Vegas and the Thetas are all relatively neutral not much activity there so if we look at this graphically you can see we've got some downward price protection especially if the market goes off the rails and sells off below the out-of-the-money put level to where that becomes in the money again at 1750 or lower you're neutral to price activity if but if the market goes above your call price of 1950 you're also going to be not participating in any more of the upside move because of the short call position but between those two strikes you're getting some adverse price protection to the downside if prices sell off and you're still participating but to a lesser degree to a positive price action should markets trade higher so what you've seen are three examples of how options could be used to protect a long position in a commodity and in this case it does it the same examples that I've been using for gold could be applied to copper or any other metal but they could also be applied to any other options prod or any other commodity contract as well and adverse price movements are not just to the downside we could also apply strategies using options if the adverse price move was to say something sharply higher the difference would be we instead of using puts we would be using calls in our is our is our working example in those things and we could just as easily do that for upward price movement if the higher prices is the adverse price move to the risk manager or the trader's position all of these options contracts are actively traded in our leading benchmark products there are very large and fast-growing part of CME's trading volume and not just at CME but in every futures exchange around the world that lists options options are a fast-growing product because of their usefulness as you've seen in both risk management functions but also in trading applications I'm going to pause there and open up the forum questions for either Eric or myself and I'm going to stop sharing my screen so that we can both both participate here Eric feel free to jump in here if you see something in the chat box that's worthy of response yeah I'm going to take a quick a quick yeah a quick read through what we have here and see what we've got to see if there's anything that we can answer and help with all right that one question looks a little long for us to be able to answer at this point yeah yeah that's an interesting question but I don't have a lot of expertise on what's going on in the Egyptian market yeah I don't know but I mean this is a essentially what's happening in Egypt is in some ways you know in some ways not that dissimilar to what's happening in other countries I mean look I have my money I mean a lot of it's a lot of my own personal money is invested in like stocks or bonds or gold or whatever but you know some of it does sit in bank accounts I mean not a lot of it but you know in the US or the UK if you had money sitting at a bank account it lost you know 10% of its value over the course of the last few years maybe more maybe like 12 or 15% when you compounded out for two years yes there's just been a really tough position to have any sort of you know money sitting in bank deposits is that is that is that because of the way inflation eats into the value of the currency itself yeah that's right yeah I mean essentially inflation you could view it is it's two ways you view it as a way to rate at which prices rise being from the perspective of a currency or you could view it as the rate at which a currency loses value versus inflation or versus versus you know real real good that you would you would need to buy so if you have 10% inflation that means that you've lost your money is lost 9% of its value versus good you know if you have 25% inflation that means you've lost 20% of your of your currencies value and like I know that Egypt like many other countries has suffered from high rates of inflation and you know in many cases like even in the US where the Fed has rates up at you know four and a half percent I think banks are only paying maybe 2% interest now so we have 6% inflation this year and interest is 2% you're still at negative 4% so I think that's why a lot of investors you know are still interested in things like gold and silver because they hold their value unlike the currencies do we have any other questions coming through I think there may have been another question that popped up can you open the Q&A box yeah yeah well I have it open on my screen yeah do I mean to read it there's one about the UK and Europe Brexit that yeah you might be yeah that would that one just popped up the saying it says in the event of UK and Europe Brexit how EU market decisions impacted the UK market how directly or indirectly is the market correlated okay yeah so in the context of fixed income the UK and European markets prayed very closely with respect to one another they're not exactly the same because the Bank of England has complete control over or more or less complete control over short-term interest rates in the UK whereas the European Central Bank has more or less complete control over short-term interest rates in Europe but when you go further up the yield curve when you start looking at say 10 year bonds which is what the guilt future is based on or you know 10 year bonds in Europe which is what futures on say the OAT in France or the German Bund or the Italian Bono are based on those do tend to move together but Europe has a sort of you'd be Eurozone has a sort of special quality to it that's very unlike the UK or the US and what makes it different is that you essentially have a bunch of countries emitting debt into a common currency that none of them control so it's sort of like more like a municipal bond market and this is why you see the spread changing between European bonds you know so one of the big risks I think is that with tighter monetary policy Italian bonds Greek bonds maybe even French bonds could wind up selling off versus Germany but that would not necessarily have any direct impact at all on the United Kingdom is UK like the US has one sovereign issuer the UK Treasury or the US Treasury is doing into one currency that's controlled by a central bank that is also essentially reporting to that government so in the case of the UK it's the Bank of England in the case of the US it's the Federal Reserve but that's not however true in Europe where you have many different countries issuing debt into a currency that's created by the European Central Bank in no one country has complete control of the ECB you know I think that there are there is a lot of influence so when you look at long-term rates around the world they're also very influenced by what's happening in the US Treasury market US Treasury market sort of the dominant actor among interest rates and so the gilt market as well as the bond market in the eurozone tend to follow to some extent what's happening in the Treasury market because it reflects essentially the yields on US treasuries versus other bonds reflect a global competition to raise capital in these markets and so that there can be changes in the spreads versus these bonds but they often do move in tandem we have any other questions I don't see anything else coming through yet but we all know that's few other things to pop up would you advise me on something to get out of this crisis well yeah this I guess response to the Egypt question fortunately I can't really give you any financial advice and I don't really have a lot of expertise and what's happening in Egypt so unfortunately I'm not really in a position to offer you advice I'm sorry do we have any other questions coming through I don't see any other questions no nothing at this point you know from my part then I will we wish everyone the very best of success thank you for your time and you're interested CME and I would like to just give a quick plug to the educational portal CME Institute which is available at CME group comm under the education tab at the top of the of the website by all means make avail yourself to the wonderful resources that are available there's there's core curriculum there are webinars archived webinars as well as content from third party providers on all of our markets all of our products some of which Eric has provided and some have come from others as well it's a great resource that you can explore at your own time and at your own pace to make yourselves a little more educated about our markets and our products thank you for your time today and then I'll leave the rest of it for you Eric all right well thank you all very much I hope you found it helpful and I think we're going to come back with at least one more webinar I think in April if that's correct so I'm looking forward to that as well thank you all so much and have a good rest of your day cheers bye