News of Saudi Arabia air strikes against Yemen led to a super spike in crude oil prices overnight. West Texas Intermediate crude oil jumped as much as 7% to $52.48 a barrel before falling back slightly.
With prices having already fallen so low, continued turmoil in the Middle East will inject additional upside risk in the oil markets. This added variable should weaken the bears’ resolve while emboldening those playing for a bottom in oil and oil stocks.
From a technical standpoint, today’s oil spike amplified the nascent rebound in crude. In my recent missive on the United States Oil Fund LP (ETF) (NYSEARCA:USO) I laid out two potential bullish scenarios, one of which has come to pass — a failed breakdown.
In light of the war premium now being priced into the USO ETF, let’s take a renewed look at the price chart to see how traders should position themselves going forward.
The two dominant developments aiding USO bulls are the recent failed breakdown bid along with momentum divergence.
The failed break below the $16.25 support zone (green line in chart) acted as a bear trap of sorts. Anyone who shorted the breakdown is now in a world of hurt and is a potential buyer as USO continues rising. This potential source of added demand will help support prices of oil going forward.
The RSI indicator is flashing a bullish divergence signal. While USO has been carving out lower lows the RSI has been establishing higher lows (black dotted line). This momentum divergence suggests the strength of the oil downtrend is waning. In other words, the downtrend in oil may be nearing its end.
Top 2 Trade Ideas for USO
Put sell: Despite the recent bullish activity in USO, prices have risen a lot in a short period of time. With today’s pop USO is already up 15% in the past seven trading days alone. I’m not a fan of chasing here. If you’ve yet to wade into the oil patch with bullish plays, consider waiting for a pullback.
Following a multi-day drop, sell May USO puts. If the May $15 puts are able to rise to around 50 cents, sell them. Your reward will be limited to the initial 50-cent premium. By selling the put you’ll be obligated to buy USO at $15 if it declines below that price by May expiration.
Call sell: A second play worth consideration is selling May $20 calls as a means of fading the current oil rally. With prices up so much already USO may be due for some profit taking. If you think it fails to rise to $20 by May expiration you can sell the May $20 calls for around 40 cents.
The maximum reward is limited to the initial 40-cent credit and will be captured if USO remains below $20. By selling the call you obligate yourself to sell shares of USO should it rise above $20.
At the time of this writing, Tyler Craig owned short puts on USO.
