by Tyler Craig | July 6, 2012 2:25 pm
Over the past week, oil’s multi-month slide was halted by a sharp $10 advance — reminding traders once again that tensions in the Middle East are an oil bull’s best friend. Since rising from $77 to just under $89, oil has pared back its gains and fallen to $85 in response to Friday morning’s weaker-than-expected jobs report.
For those willing to bet the recent lows at $77 will hold for the next month, the current pullback presents an alluring opportunity to sell out-of-the-money put options on the United States Oil Fund (NYSEARCA:USO).
By selling a put option, traders obligate themselves to buy stock at the strike price if the put option moves in-the-money by expiration. If the put remains out-of-the-money, it expires worthless, allowing traders to capture the initial credit received at trade entry. Consider selling puts as a bet that the underlying asset will fail to fall below the put option’s strike price.
When employing short puts, traders typically use shorter-dated options to exploit the higher rate of time decay as well as to shorten the amount of time they’re exposed to an adverse move in the underlying asset. The ideal option to sell, then, is one with around three to seven weeks remaining to expiration.
With USO currently trading around $31.80, the August 29 put can be sold for 56 cents. With a delta of 22, this short put offers a probability of profit around 78%. Traders looking for a more aggressive bet might consider selling the August 30 put for 83 cents. With a delta of 30, it currently provides a probability of profit around 70%.
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