After Tremendous Drop, Oil Establishes Range
| Feb 06, 2016 04:23PM ET
After a tremendous drop, crude oil seems to be establishing a range.
I think this continues for some time, as the large oil-producing countries work together to stabilize prices. The current price already reflects the slower growth in China and other developing countries.
Long term I am bullish on oil, as it is not profitable for many of the producers at these levels. As investment drops, supply will follow. Once these producers are out of the market, I also believe OPEC producers will cutback in output, causing more upward pressure on oil prices.
I would look to sell out of the money put options on the United States Oil Fund ETF (N:USO), to capitalize on this trend.
This strategy does have risks. Keep in mind oil has been very volatile recently. It has gone from 60 USD/bbl last May, to 31 USD/bbl today. By selling options, you take on more risk then buying or selling the underlying, since options involve the use of leverage. Keep in mind, each contract represents 100 shares of the underlying. However, the out of the money options have a relatively high implied volatility. So, you are being paid to take that risk.
Having said that, I am looking specifically at selling the 8.50 February 19th puts. USO is trading at 8.91 right now. These puts are trading at 0.29. You can see that the implied volatility is 69.6% vs. a historical volatility of 43.6% of the underlying. A higher implied volatility equals a higher premium, resulting in more income from selling puts.
If you sell 10 of these options, you will receive a premium of $290.
If USO is below 8.50 at expiration, you end up having to buy 1,000 shares at 8.50. Which would be an effective price of 8.21 (8.50 minus the 0.29 premium). If USO is is above 8.50 at expiration, you keep the premium. Not a bad deal either way.
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