It is Time to Ride another Rally

During the past six weeks, oil prices have fallen more than 20%. Some observers are calling this retreat a new bear market, since the parameters in percentage terms for such a declaration have been met.

When a market is down, it may seem easy to project its short-term future and expect oil to go down further. We are taking a different view today. We believe between now and October, oil will rally once again. How much it rallies will depend on global consumption but we are calling for a rally in oil. As a result, we have designed a trade that will be very inexpensive to implement and potentially highly profitable. Here’s how it will work.

We are going to sell the United States Oil ETF (USO) October $8.50 put options (USO161021P00008500) currently trading at 35 cents. The options expire Oct. 21. This trade is going to generate premium income for us that will be used to buy the USO October $10 call options (USO161021C00010000) that currently are trading at 51 cents and also expire Oct. 21. This means the total cost of the trade will be 16 cents. Now if the price of USO falls to $8.50 or lower before expiration, we may recommend the purchase of those USO contracts, but we expect they will expire at zero and allow us to pocket the premium. If oil rallies as we expect over the next few months, we will profit on the call option.

We believe this is a low-risk way to make profits as we see it today, given the backdrop of improving economic conditions. While economic growth certainly isn’t robust, it is far from recessionary. As a result, the conditions do not warrant oil hitting new lows.  In our opinion, this sell-off in oil is simply the digestion of an overdone rally. When the dust settles, crude oil prices should end up within an established high/low range.

On a housekeeping note, please be advised that on July 25, UVXY implemented a reverse 1-for-5 stock split. This reverse stock split does not affect the market value of the position. It simply decreases your number of shares by a factor of 5 while increasing the price of each share by the same factor of 5, as well as boosting our adjusted entry point. Reverse splits are fairly common occurrences and, with ETFs, they should be perceived as a neutral event for shareholders.