Making Two New Trades in the Energy Sector

We have traded oil quite successfully during the past two months and it’s time to go back to where we have made money in the past. Oil has had a big two-week rally. United States Oil Fund (USO), which tracks the price movement of WTI crude, is trading at its highest level of the year this week. With Russia and Middle Eastern countries sending representatives to meet next week to try and to find a way to at the very least freeze and, less likely, cut production, we think this meeting could end in a bust.

There still is too much supply in the world today. The supply is high, the demand is weak and it is a bad combination for oil prices. Moreover, the threat of additional supply coming at higher prices will do a lot to keep prices at bay for the time being.

On the other hand, the economies of energy-producing countries like Saudi Arabia and Russia are struggling. In fact, Saudi Arabia’s credit rating just got downgraded by another rating agency and it is on negative watch for another downgrade. These countries need a rebound in energy prices as these profits go directly into keeping public entitlements afloat.

Previously, the Saudis have insisted on Iran participating in the freeze but just yesterday they announced they would be willing to move forward without the Iranians. How’s that change of attitude for acknowledgment of pending problems?

Now, here is today’s recommendation. Given that uncertainty over the outcome of this meeting is the only certainty, we want to be buyers of volatility and not make a call on the direction of the eergy sector. We believe the price of oil could move dramatically higher due to the large amount of short interest or it could crater on disappointment. With these factors in mind, when you receive this alert, buy the United States Oil Fund May $10 puts (USO160520P00010000), which expire on May 20 and which last priced at 36 cents, and buy the United States Oil Fund May $11 calls (USO160520C00011000), which expire on May 20 and which last priced at 44 cents. This strategy is called a strangle. Our risk is limited to the cost of the trades but our profit is unlimited once USO moves below or above our cost.