by Tyler Craig | December 12, 2013 8:53 am
With crude oil encroaching on bear country, the bulls have finally staged a successful counterattack. The crumbling commodity’s three-month, 18% drop brought it oh-so-close to Wall Street’s widely accepted threshold for a bear market — a 20% decline. While all prior attempts at resurrecting black gold amid its descent proved fleeting, the current one might finally succeed.
And with that, bullish option plays on the United States Oil Fund (USO) are starting to look attractive again.
Heading into December, crude oil, alongside the broader commodity complex, was limping into year-end like a wounded dog. Prior to its latest rebound, crude oil was essentially flat on the year, while the Powershares DB Commodity Index (DBC) — a basket of 31 different commodities — was down some 7%.
Compared to the 25% year-to-date gain on the S&P 500 Index, the poor showing in Commodity Land is downright depressing, particularly for those who were betting on a bigger jump in inflation this year.
The recent recovery in oil cleared two major hurdles: the 20- and 50- day moving averages. Given both the magnitude and duration of the ongoing rebound, the 20-day moving average also has turned a corner and is heading higher. Further buttressing the bull case is the higher-than-average volume accompanying the surge.
With buyers now on the offensive, further downside in crude oil should be somewhat limited.
Of course, with crude oil having already jumped 7.5%, a pullback would be a welcome development, providing a lower-risk entry point for those looking for additional upside in the commodity. Following any type of drop in USO over the coming week, consider buying Feb 34-36 call spreads to position yourself to profit from oil’s turnaround.
To enter the position, buy the USO Feb 34 call while selling the Feb 36 call. The max risk is limited to the initial debit, while the max reward is limited to the distance between strikes minus the net debit. With this USO call spread currently trading around $1, the max risk is $100 while the max reward is $100.
After a pullback in USO, however, you should be able to buy the spread cheaper — around 80 to 90 cents.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
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