The seemingly endless slide in oil has left many a contrarian maimed and wounded in its wake. Any and all attempts at picking a short-term bottom in the crashing commodity have been futile, until yesterday that is.
Wall Street’s favorite oil ETF, the United States Oil Fund LP (ETF) (USO), finally scored a convincing bounce lifting the grossly oversold fund 3.7% by day’s end. The rally was accompanied by monster volume, suggesting at least a short-term low has been established … and perhaps counter-trend plays are worth a shot.
Bear in mind that the downtrend in the USO ETF remains well intact, so more evidence is needed before calling for a turn in the overall trend.
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Unsurprisingly, the implied volatility for USO options is through the roof, which tells us the price traders are paying for options is quite elevated. This favors an option selling strategy for those wanting to try their hand at gaming USO in the coming weeks.
USO Puts Ripe for the Pickin’
My strategy of choice for an underlying security in the high teens that boasts expensive options is a short put play.
For example, you could sell the Feb $17 USO put for around 62 cents. The max reward is limited to the initial 62 cents and will be captured if the oil ETF remains above $17. Due to the initial credit received, the expiration breakeven is actually $16.38 ($17 – $0.62). By selling the put, you are obligated to buy USO at $17 if the put sits in the money at expiration.
The key for being successful when using option strategies with open-ended risk like the short put lies in proper position sizing. Keep the number of contracts small so the amount of risk is minimal compared to your overall portfolio.
Should USO gap up in the next couple of days, rather than chasing the rebound, you could wait for a slight dip in oil intraday or even the next few days to get the 62 cents in the Feb $17 put. Use a limit order and let the market come to you.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
