A relentless price drilling to multiyear lows this year in the United States Oil Fund LP (ETF) (NYSEARCA:USO) may have finally found a technical floor attractive enough for investors to buy shares of USO as an intermediate-term commitment.
There are no guarantees other than death and taxes that a bottom in USO shares is in place — well, other than if WTI or Brent crude trade to zero. Then again, we probably wouldn’t want that trade anyway, as we’d likely be back to the Stone Age.
Caveats in place, for bulls wanting to play a significant technical low in the USO ETF right now while ensuring ‘this bottom’ has definitive, built-in protection against further fracking of your investment, the collar spread is an attractive hedged position.
USO Technical Forecast
Getting past the daily headline noise of what’s impacting oil prices today and which for the better part of the past nine months (and today), has been mostly relentless in their bearish overtures; traders can choose to focus on the big technical picture in USO stock. The weekly chart of the United States Oil Fund and shown here, is one such view.
After setting a high last June and failing to move higher, the USO ETF established a double top formation. From that pattern top, USO has slid for the better part of nine months and falling by a very volatile 60%.
Most recently and as part of this volatile backdrop, there is now technical evidence in place suggesting a trend change to the upside could be underway in USO. On the weekly chart, the US Oil Fund has put together a lower, low double bottom with a moving average convergence divergence (MACD) crossover and positive divergence during its development. The MACD indicator is a tool to gauge a stock’s momentum.
Additionally and also viewed as a positive fixture for bullish positioning in USO, massive record-breaking volume during the building of this potential low appears to a possible capitulation by investors. Further and of interest for the USO’s own technical fortunes; a massive bullish wick pattern and prior price drilling in crude oil are quite bullish if historical tendencies prevail.
USO Volatility Alert
Taking another look at the United States Oil Fund chart, not yet examined but very important to traders, is the brown line representing USO’s underlying price volatility and related implied volatility line, which measures how options are being priced.
What is obvious is both measurements for USO are very high — as high as they’ve been in a few years. Volatility, both underlying and implied, generally moves lower as USO stock goes up in price or trades laterally in a range.
This volatility phenomenon known as ‘volatility crush’ is far from unique and historically pervasive in most tradable instruments. That said and with the thesis for a bullish low in USO in mind, one thing that could potentially prove very costly for an option trader is being correct on direction, but placing the wrong bet in USO ETF options.
Long calls, long straddles are two high-risk plays in a situation like the one in USO. Volatility crush can counter profits that were supposed to be made from the option’s directional component known as delta. Secondly, the length of time to reach one’s profit objective can also be highly detrimental to both of these long premium positions.
Bullish Collar US Oil Fund
A collar in the USO ETF is an attractive intermediate-term solution for investors wishing to own shares and quantify their risk to an absolute floor or dollar amount without fear of a future decline in shares of USO. The collar also drastically cuts down on the volatility and time decay risks as the long put that offers downside insurance is financed with an equivalent amount of short calls.
The big, but very acceptable compromise with a collar is this type bullish trader will generally make less profits on the upside than an investor with naked long USO shares. That’s because the long put and short call have a bearish delta and are structured to cap the profit potential, barring adjustments, in the same way a vertical spread does.
Based on what’s been presented, a USO collar packaged using a short May $19.50 call and long May $15.50 put with long stock trades for about $17.55 with shares of USO at $17.50. At the end of the day, the additional 5 cents to own shares allows a bullish trader piece of mind knowing if things go terribly wrong and USO is drilled to new lows, the max loss is still limited to $2.05.
Alternatively, if at May expiration shares of USO are at $19.50, the trader makes a nearly identical profit of $1.95. If USO gushes even higher in the interim, there is a profit cap in place with the collar. However, adjustments i.e. rolling the call and put during a profitable move higher can amplify those returns.
The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. As of this writing, he did not hold a position in USO but may initiate, for better or worse, a position in two or more business days following the publication of this article.
