Bottom fishers in the oil patch have been bruised and battered. Theirs has been a desperate gambit fraught with difficulty in recent months .. but the tides may be turning. Monday’s shellacking was accompanied by something we haven’t seen in many moons — a signal that suggest capitulation is imminent: extreme fear.
The United States Oil Fund LP (ETF) (USO) was down 5.6% Monday on oh-my-gosh volume. The relentless crash has brought oil low. Crude oil futures now sit a mere pebble toss from the $20’s.
So what of this fear I speak of?
Options on USO have their own volatility Index. It’s just like the CBOE Volatility Index (VIX) for the S&P 500. The CBOE Crude Oil Volatility Index (OVX) is just the tool for measuring sentiment in the oil pits.
When traders start running around with their collective hair on fire, they tend to rush into the options markets to buy options for protection. This massive uptick in demand sends option premiums to the stratosphere.
The oil VIX spikes when such a phenomenon plays out.
And Monday, it spiked big time.
With option prices now massively inflated on USO, it’s high time to strike for those looking to get in on the action. USO option sellers are receiving more compensation now than at any time in the past year.
The USO Fear Trade
Brave souls willing to attempt the ol’ knife catch should consider selling USO put options. If oil prices finally stabilize, naked puts will deliver the goodies. With USO hovering around $9.25, you could sell the February $8.50 put for 35 cents.
The max reward is limited to the initial 35 cents and will be captured if USO remains above $8.50 over the next month. And before you scoff at the 35 cents, bear in mind the margin requirement or cost for a naked put on USO should be around $100 or less, so we’re talking about a massively appealing return on investment here.
If oil prices continue plumbing the depths, the short $8.50 put does obligate you to buy 100 shares of USO if the put sits in the money at expiration. That price level on USO corresponds to oil in the high twenties, so if you have a longer-term bullish view on black gold, it may not be a bad idea to accumulate shares of the oil ETF down here anyways.
At the time of this writing Tyler Craig owned short put and call positions in USO.
