Will Iran dismantle its nuclear program? The wild card is atop crude oil traders’ list of immediate catalysts to dismantle the commodity’s tight 2½-month trading range. But with plenty of other potential supply and demand agitators in the mix, well-priced options in the United States Oil Fund (USO) set up a long strangle in the USO ETF as a smart way to position.
Nuclear program talks with Iran stalled this past week and to the point that many analysts are conceding a Tuesday agreement deadline will be pushed out by a couple months. Were that to occur, Iranian supply estimated at 1 million barrels a day, coupled with tanker stockpiles of 30-40 million barrels would be stopped from re-entering the market.
That’s bullish for oil prices and shares of the USO ETF.
Conversely, were a deal to get signed, its estimated a quick 10% to possibly 15% move lower would be in store for oil prices and the attached-at-the-hip USO ETF. But while Iran appears to be the most pressing factor for traders, it isn’t the end game for the USO ETF breaking its trading range either.
One only has to consider other bearish and bullish dynamics like existing oversupply of 2 million barrels daily, U.S. production at 40-year highs, massive stockpiling of crude by China, Chinese stock market volatility, Greece and the U.S. dollar to appreciate that the USO ETF is likely near a tipping point technically and set to break free from its current trading range.
USO ETF Stock Daily Chart
A simple inspection of the daily USO ETF chart shows the aforementioned tight, lateral trading range of the past couple months. A slightly deeper kicking of the chart’s technical tires suggests the upper hand rests with the bears and lower prices ahead.
First and most simple, price action in the USO ETF has been consolidating below its 2009 lows (black horizontal line) and the long-term 200-day simple moving average. Secondly, as of late last week the USO ETF broke below 50-day support as the 10-day average made a bearish cross of the intermediate term moving average.
Lastly, the current trading range in the USO ETF has stalled at 23% and 38% Fibonacci levels, which are acting as technical resistance. The two retracement levels were drawn from 2014’s highs and 2009 support (i.e. the former financial crisis lows) down to the 2015 lows.
For USO ETF bulls, the evidence for higher prices appears scant but, new trends don’t typically send out RSVPs as their building in their earliest stages. Coupled with what was a massive sell-off during 2014 into 2015 and one that plowed right through the 2009 lows, appreciating the power of that sort of correction as capitulatory in nature is given merit.
USO ETF Long Strangle
Given we’re open to the possibility of the USO ETF moving in either direction out of its trading range, though modestly favoring lower prices, a long strangle wherein a long out-of-the-money call and put are purchased is enticing.
This strategy that profits from both large price movement and/or an increase in implied volatility is made more attractive as volatility has come in by about 60% from its lowly 2014 levels to the USO ETF’s panic highs set in early 2015.
In reviewing the USO ETF options board, the Sep $22 call/$18 put for a debit of 87 cents fits nicely with what’s been discussed. The pricing on an expiration basis does require a move of 15% to break even. However, with plenty of time on the calendar and anticipating a move in the USO ETF out of the range will happen sooner rather than later, but not wanting to deal with time-sensitive maturities; September makes sense.
Volatility risk could still pose an issue with the USO ETF September strangle, but we’d anticipate any harm of pressured implieds would be more than offset by a strong move out of the trading range. Additionally, while it may not be possible or attractive due to gap risk, the long strangle trader might look to sell the long contract that is on the wrong side of the breakout to further cut down risk.
As of this writing, investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon his observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT.
