Name That Trade – Crude Oil Inflection Point, $USO

by Enis May 31, 2013 10:26 am • Commentary

I mentioned the developing wedge in both the SPX and crude oil in this morning’s macro wrap.  Crude oil is especially interesting because the WTI contract has developed a long-term wedge, but the European Brent crude contract has a slightly different pattern, dominated by a very important short-term support line that has been tested on multiple occasions in May:

Front month Brent crude oil, 30 day chart, Courtesy of Bloomberg
Front month Brent crude oil, 30 day chart, Courtesy of Bloomberg

Today is basically the 5th test of that support level, and the more times a support or resistance level is tested, the weaker it gets.  If that 101 level in Brent crude does break in the next week, I expect a much larger move lower from there.

There is no good, liquid ETF to play Brent crude, but the USO ETF is designed to follow the WTI front-month contract (and is poorly structure, so has a natural bleed to it as well).  Brent and WTI have a 81% correlation over the last year.  The 1 year chart of USO:

1 year daily chart of USO with 200 day ma in black, Courtesy of Bloomberg
1 year daily chart of USO with 200 day ma in black, Courtesy of Bloomberg

The 31 level in USO is the key area of support (trading around 33 right now).  Here are a few structures that look interesting to play for a move back to the level (doing nothing myself):  

Buy the June22nd expiry 32 / 31 put spread for $0.21.  This is the trade that is in anticipation of an imminent break in support.

Sell the July 33 / 35 call spread at $0.75.  This trade would fit a view that a rapid break lower is not necessarily imminent, but oil’s upside over the next couple months is capped, and a range trade continues.

I’m not going to initiate a new trade on USO today as I am already a bit exposed to that theme (namely, my FXC trade), but it’s an interesting setup regardless.