How to trade inflation

Often times traders like to buy and sit back. At certain times this is ideal while other times it can spell disaster. When inflation raises its head, many run for anything tangible since that is what they have been taught keeps their value. While true, it does not mean all things act the same way. I remember friends buying gold at 850 an ounce in the 80's with the same arguments we hear today. Now I am not saying gold is topping, I am merely stating that while inflation causes tangibles to go up, not everything is the right time.

For example, wheat has formed an obvious bubble, while water is barely getting back on its feet. Gold has seen a steady incline which should continue for some time. Once the media gets all over this and we have a declared "new currency" in gold then you will know this too will become a bubble. One key factor is the junior companies (the ones you get emailed to you all the time) this is the first sign of the impending bubble.

A smarter way would be to trade the tangibles that have not seen the meteoric rises such as water as previouly mentioned, meats, sugar etc. For those that do not like to trade commodities such as I, then we trade baskets of stocks like PHO for water.

So what does this have to do with options? Finding the trend is always the best way to make money. If you can find the trend first with the smart money you can ride it out until the media frenzy that creates the bubble and get out. Using LEAPS to take advantage of the long term trend works, but you are losing to time decay with each passing day. A way to combate the time decay is to sell a front month. You can calculate how much time decay is taking place and sell the appropriate option to cover this part of options trading that is detrimental.

By doing this, you will experience the long term trend appreciation on the LEAP while offsetting any time decay with the premium collected from the short month. This strategy is called the diagonal spread. You sell the short month, higher strike that you wish to collect the premium from to offset the time decay while you wait for the underlying to move.

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