Oil Topping out

Oil has reached $50 twice in the last few weeks. We have had a tremendous rally in oil since the lows reached in February. Today, we started to see a breakdown in crude.

We believe oil could be at a short-term top and that we should take advantage of a change in direction to the downside. We advise buying the United States Oil July $11.50 put options (USO160715P00011500), which last traded at 77 cents and expire July 15, and buying the exchange-traded fund (ETF) ProShares UltraShort Bloomberg Crude Oil (SCO), which is a leveraged short bet. Implied volatility on USO has also traded to a level slightly below its short-term average. That situation indicates that complacency may be creeping in and, of course, we can buy cheaper volatility.

Since the February lows, the recovery in the stock market has been in part fueled by the recovery in oil. We believe for the short term that this relationship will hold true. With a potential lid on oil prices, we should see a pause in the energy sector rally to keep the markets range-bound. Should this play out as we expect, we stand to benefit both from this most recent trade and from our positioning in a previous SPDR S&P 500 ETF (SPY) call spread trade, too.

Best,

Doug and Tom