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Unconventional Ways to Trade the Oil Panic

USO call options paid off handsomely -- what to do next

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I am well aware of the roll problem with the USO, where the futures exchange-traded fund (ETF) loses value every time the front-month futures expire and the portfolio needs to be rolled into the next month’s (slightly more expensive) futures. This causes huge problems over time, but it is largely irrelevant over a one- or two-month time frame as oil goes parabolic; the USO will rise slightly less than WTI crude oil futures because of this. I will never recommend USO as a buy-and-hold vehicle — or the U.S. Natural Gas Fund (NYSE: UNG) for that matter — but for short-term trading it serves a valid purpose.

It is impossible to put a precise target on the price of oil, as the situation is highly fluid. Anyone trading this mess must be willing to make a judgment call and get out of positions aggressively on their own.

There is an interesting spread trading ETF that might make sense, too, the FactorShares 2X: Oil Bull/S&P 500 Bear (NYSE: FOL), which does exactly what its name suggests. Introduced in late February, FOL is designed to perform at twice the daily return of the S&P Crude Oil – Equity Spread Total Return Index. The fund does this through a leveraged long position in Light Sweet Crude Oil Futures and a leveraged short position in the E-Mini S&P 500 Stock Price Index Futures.

“Daily” is the key word here as both bullish and bearish leveraged ETFs decline over time if their underlying index stays flat in a trading range. This is because of “reverse compounding” of sorts that magnifies the effect of the old mathematical dilemma that a 50% decline needs a 100% rally to go to break even. Since this is a relatively short-term trade idea, this should not be a huge issue, even though it should be highly volatile.

Too Many Dollars, Bonds?

As to any calls or bullish put credit spreads on the iShares Barclays 20+ Year Treasury Bond Fund (NYSE: TLT) that I had suggested, they clearly have not worked out as well. With a credit spread, the options’ time decay works in your favor, while with a long calls trade, it works against you. It looks to me that if oil keeps going higher on further escalation, we should still see a short-term bullish effect on bonds.

Still, the fact that neither the U.S. dollar nor U.S. Treasuries are seeing a safety bid in a time of a geopolitical crisis says a lot about the monetary and fiscal situation we are now facing. Is this because we’re seeing simply too much supply of dollars and Treasury bonds? It certainly looks that way to me.

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