Do You Really Know How To Trade Ticker USO?

Markets are closed so let's talk shop. Here is a great article from our friends at Wolf Option Trading. Let's see how they trade the USO contango and how to partially offset it.......

The United States Oil ETF, LP (USO) is a twin of The United States Natural Gas ETF, LP (UNG), a futures based ETF that encounters issues with contango. If you are investing in futures based ETFs you should already be familiar with the issue and know how it impacts the funds. Thereby, I am not going to go into great detail about the pitfalls, but simply talk about it briefly.

USO owns crude at $85 and by this time next year the futures are pricing crude at $90 or roughly 6%. If all remains the same, this means that anyone buying USO today will not make money and instead lose money, if oil stays below $90. A year of losing money unless prices go up by more than 6% is never fun.

The bright side of this dark oily substance has many folds. Since oil is denominated in US dollars, you have traders that use it as a dollar hedge trade, bad for oil prices going up when a flight to safety is occuring. However, the world will not always live in fear and when it stops, then the trades get reversed and oil and USO then will go up. Oil has many more types of traders (aside from actual fundamental supply/demand folks) such as inflation hedgers, gold/oil ratio folks, oil/natural gas ratio folks, brent/wti ratio folks and a good amount more I am probably neglecting to mention. Fundamentally, the case for higher oil prices is strong and only further economic weakness would cause prices to go substantially lower.

It is likely oil prices will be much higher in the future than $85, but for folks buying USO they have to factor in the amount of contango they will face in order to see if it is a wise time to buy and hold currently. My take is that is probably early to buy crude at $85 and speculate that it will be above $90 by this time next year. There could be a better entry for a buy and hold investor.

However, everyone always has that itch to be more aggressive or look for more bullish things than may exist. I am not immune and it takes a lot of self discipline to be more strategic and wait for better opportunities.

The only easy way to partially offset contango is by being a net seller of options. Many options strategies are available that allow you to be a net seller of options while being bullish on the underlying instrument. Probably the most attractive strategy in my opinion is selling puts greater than 5% OTM and buying an ATM call spread.

For USO, January 2013 options are the only ones available to express a view past April 2012. January 2013 $25 put options are roughly 32% OTM but fetch a net credit of $2.45. The $34-45 January 2013 call spreads would cost $3.49. A net debit of $1.04.

The trade essentially would get you bullish on oil at $57 without factoring in contango. However, if one assumes that contango would be 15% (random) then one would be long oil at $70. The call spread gives one upside in oil prices up to $115 before getting called away from the trade if there was no contango. If one were to factor in a 15% contango rate, then oil prices would have to be $132 to get called away.

Total profits on the trade would be very high if one were to get called away at $45. The returns against total cash involved in the trade would be $9.96 net profits against a $1.04 net debit. However, that can be deceiving as margin requirements would be higher than the net debit but those vary across brokerage firms. The MVAR would be the better calculation and that would be the cost average one would be assigned USO at. $26.05 is the cost average of the total trade ($1.04 net debit added onto the $25 short puts) and a $9.96 net profit / $26.05 would still get one a 38.24%.

Overall, the trade is a good one for people speculating on much higher oil prices than $85 in a year's time, yet doesn't force one to take on shares at current prices.

Posted courtesy of Wolf Option Trading

Disclosure: The author does not have positions in any stocks mentioned, but may initiate a long position in USO over the next 72 hours.

J.W. Jones: Labor Day Special

If you are a regular reader here and have followed the amazing trades made in 2011 by our affiliate J.W. Jones, then it might be time to take him up on this Labor Special. Sign up now and get 3 months for the price of 1 with JW's options trading newsletter. And see for yourself how you can profit from his service!

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You ARE a Hedge Fund Manager.....So What Are The Most Successful Managers Buying?

Sometimes we don't see it, but every one of you reading this that have taken the step to manage your own money, your own fund....you are a hedge fund manager [you are hedging, aren't you?]. And like any business, yes you are in business to make yourself money, you should look at what your peers are buying.

Two of my favorite sites are Insider Monkey and Guru Focus. How can you even think about adding crude oil and energy stocks to your portfolio without looking at what the most successful people in our industry are buying.

I will let you do your own research, but I have been surprised at some of the small american producers that are showing up in the portfolios of the "great oil minds". Names like Plains Exploration and Production Company, ticker PXP, Sandridge Energy ticker SD, Murphy Oil Corp. ticker MUR and Gastar Exploration ticker GST. Gastar? A small company that just received permits to drill in Utah and should producing oil by October.

Markets are closed and it's a slow news period for the Labor Day weekend so take some time and see what these guys are buying.

Traders Always Let Us Know Where They Stand Before a Long Weekend...And it Doesn't Look Good!

The crude oil bears have a renewed advantage as bad news in employment numbers as well as a fresh round of "goal post moving" from Washington creates global investment anxiety. Falling the most it has in two weeks.

Crude oil closed lower on Friday due to the bad news and profit taking as it consolidates some of the rally off August's low. The low range close sets the stage for a steady to lower opening on Tuesday. Make sure you know when the world is trading as this is a holiday weekend. Check out our post Labor Day CME Hours so you won't get tripped up.

The oil companies themselves will not be taking a holiday weekend as Tropical Storm Lee has producers working around the clock to secure platforms, rigs and personal in the Gulf of Mexico. If the storm lives up to predictions it could limit product flow out of the gulf to 50% of normal production. And oil prices still fell today?

Stochastics and the RSI remain overbought and closes above the reaction high crossing at 89.19 are needed to confirm that a low has been posted. If October renews this summer's decline, the 75% retracement level of the 2009-2011 rally crossing at 71.72 is the next downside target.

First resistance is Thursday's high crossing at 89.90. Second resistance is the May-July downtrend line crossing near 93.88. First support is the 20 day moving average crossing at 85.51. Second support is August's low crossing at 76.15.

Labor Day CME Hours

The CME stock indexes close at 10:30 a.m. CST on Monday, September 5, 2010. If you intend on daytrading please make sure you are flat before this close as the market does not open up again until Tuesday night at 5 p.m. CST!

Here is a link for the upcoming CME holiday hours

Be very careful and aware of early closes. Every holiday we talk to experienced traders that get stuck in trades because they did not pay close enough attention to the CME holiday hours. And again, if you are using daytrade margins please make sure you are flat at the early close time.

Weak Unemployment Numbers Drive Markets Lower

Crude oil was lower due to profit taking in overnight trading as it consolidates some of this week's rally. Of course disappointing unemployment numbers have contributed to commodities and equities falling hard in early Friday trading.

Thursday trading formed a temporary top at 89.54 with the 4 hour MACD crossed below signal line. Of course the crude oil bears are thrilled with 89.61 support turned resistance remaining intact, and Friday mornings sharp decline [-3.39 as we go to press] is all the prove we need. We will remain bearish.

Closes above the reaction high crossing at 89.61 are needed to confirm that a short term low has been posted. Closes below the 20 day moving average crossing at 85.58 would signal that a short term top has been posted. If October renews the decline off May's high, the 75% retracement level of the 2009-2011 rally crossing at 71.73 is the next downside target.

First resistance is Thursday's high crossing at 89.54. Second resistance is the May-July downtrend line crossing near 93.95. First support is the 20 day moving average crossing at 85.58. Second support is the reaction low crossing at 82.95. Crude oil pivot point for Fridays trading is 89.01.

Sharon Epperson: Where is Commodities Headed on Friday?

With a new storm brewing in the Gulf of Mexico being front and center in traders minds going into Friday trading, Sharon Epperson discusses the today's activity in the commodities markets and looks at where crude oil and precious metals are likely headed tomorrow.

Fridays Open Becomes Critical For Oil Bulls to Gain The Upper Hand

Crude oil closed slightly higher on Thursday as it extends the rally off August's low. The mid range close sets the stage for a steady to higher opening on Friday. Stochastics and RSI are overbought but todays bullish close signals that the oil bulls have gained some momentum. Solid follow through is a must on Friday if the bearish trend is to come to an end anytime soon.

Oil companies with workers in the Gulf of Mexico helped to push prices to a 4 week high as evacuations started on rigs operating in the Gulf. Traders appear to be pricing in supply disruption well ahead of the storm.

Crude oil is at the top of the Donchian Trading Channel and is heavily overbought. We would not be surprised to see a pullback from current levels. At the present time our long term monthly Trade Triangle is negative, while our short term daily and weekly Trade Triangles are positive. This is creating a mixed picture for crude oil.

However, the longer term monthly Trade Triangle must be given more weight than either the daily or weekly Trade Triangles. We expect this market to pull back from current levels and from the top of its Donchian Trading Channel.

Closes above the reaction high crossing at 89.19 are needed to confirm that a low has been posted. If October renews this summer's decline, the 75% retracement level of the 2009-2011 rally crossing at 71.72 is the next downside target.

First resistance is the reaction high crossing at 89.19. Second resistance is the May-July downtrend line crossing near 94.26. First support is the reaction low crossing at 79.38. Second support is August's low crossing at 76.15.

Monthly Trade Triangles for Long Term Trends = Negative
Weekly Trade Triangles for Intermediate Term Trends = Positive
Daily Trade Triangles for Short Term Trends = Positive
Combined Strength of Trend Score = + 70

Crude Oil Bears Enjoying Strong Resistance at 89.54

Crude oil was slightly lower in overnight trading as it consolidates some of this week's rally. Stochastics and the RSI are overbought and we remain bearish with 89.54 support turned resistance still providing crude oil bears with some of the strongest resistance we have seen in some time.

Closes above the reaction high crossing at 89.19 are needed to confirm that a short term low has been posted. Closes below the 20 day moving average crossing at 85.52 would signal that a short term top has been posted. If October renews the decline off May's high, the 75% retracement level of the 2009-2011 rally crossing at 71.73 is the next downside target.

First resistance is Wednesday's high crossing at 89.54. Second resistance is the May-July downtrend line crossing near 94.35. First support is the 20 day moving average crossing at 85.52. Second support is the reaction low crossing at 82.95. Crude oil pivot point for Thursday trading is 88.67.

Dollar’s On the Verge of a Relief Rally...... Look Out!

From Chris Vermeulen of The Gold and Oil Guy.Com........

Let’s talk about the dollar for a moment… The US Dollar has been stuck in a very large trading range during the past 4 months. But when the dollar actually breaks out of this pattern in either direction we should see some big price movements across the board in stocks and commodities.

From July through mid-August I was bearish on the dollar. But over the past 2 weeks the price action has become more neutral/bullish in my opinion. Its clear there is still indecision with the dollar value because every surge in price either up or down is quickly followed by a surge in the opposite direction. The key here is that the support level down at the 73.50 area has held more than three times and now I think the downward momentum is about to shift. The UUP bullish dollar etf is a good option.

Dollar Index Chart

Gold Chart:
Looking at the gold chart I see potential for another sharp drop to the low $1600’s. While I like the look of this chart for lower prices there is still a wild card which is the Euro-Land issues… I’m not willing to bet on lower prices because we could wake up any day to some poor news which instantly sends gold higher. Rather I am waiting for things to unfold then look to buy again for another 10-20% gain on the next rally.

Crude Oil Chart:
This chart is straight forward… The trend is down and at this time all bounces are to be looked at as shorting opportunities.

SP500 Index:
The equities market has broken down sharply over the past couple months and now we are seeing a rebound and small cap stocks are making big gains. With the dollar looking bullish and stocks trading up at resistance I have a feeling we may see another downward move within the next week or so to test the lows or make a new low before putting in a real bottom.

Mid-Week Trend Trading Conclusion:

In short, I feel the market overall is leaning towards lower prices in the coming week or two. After that we will have to re-analyze because it may be a fantastic buying opportunity for stocks and commodities. Consider joining me at The Gold And Oil Guy for ETF trade ideas on the SP500, Oil, Gold, and Silver with great accuracy.