New Trade $USO – Swimming in Oil

by Enis June 3, 2013 1:31 pm • Commentary

USO is up almost 2% today, as commodities outperform while stocks underperform, a clear positioning unwind to start the month of June.  I wrote about my thoughts on USO in Friday’s Name That Trade post included below.  One data point on the fundamental side that I forgot to mention is the record-high inventory from last week.  Here is that commentary from the terrific team at Bespoke:

Crude oil inventories saw a significant build this week, even as traders were expecting a decline of 750K.  With an increase of 3 million barrels, crude oil inventories are now once again higher than they have been at any other time since 1983, and you could drive a truck through a gap between actual stockpiles and the average for this time of year.

So I’m still bearish on oil, and today’s bounce offers a nice entry point for a short-biased trade.  However, I’ve decided on a much different structure than what I was considering on Friday.

TRADE:  USO ($33.17)  Sell the July 33.5 / 34.5 Call Spread to Buy the July 32.5 / 31.5 Put Spread, collect a $0.10 credit

-Sell 1 July 33.50 Call at 0.90

-Buy 1 July 34.50 Call for 0.50

-Buy 1 July 32.50 Put for 0.84

-Sell 1 July 31.50 Put at 0.54

Break-Even on July Expiration:

Profits: At expiration, gains of 0.10 between 32.50 and 33.50, with up to 1.10 in profits between 32.50 and 31.50, max profit of 1.10 at 31.50 or below

Losses: At expiration losses of up to 0.90 between 33.60 and 34.50, and max loss of 0.90 at 34.50 or above

Here’s the risk chart for the structure:

Screen Shot 2013-06-03 at 11.17.47 AM
from TradeMonster

As you can see the structure collects the credit if there’s no big movement up or down. It quickly turns profitable with a down move and becomes a quick loser upwards, so a pretty delta intensive trade as opposed to doing just one of the spreads on its own.

 Trade Rationale:  I went out to July to give myself enough time for USO to break out of its recent 1 month range.  The long-term support on USO is around 31, which is why I chose the 31.50 level as the lower end of the put spread.  Given the current rangebound nature of USO, I chose a structure where I don’t have to pay premium upfront, but in reality, this trade is going to act like a short USO stock position for the next few weeks.

Name That Trade – Crude Oil Inflection Point $USO, May 31, 2013:  

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.