Be a Contrarian: Go Long United States Oil Fund LP (ETF) (USO)

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The broad consensus is that oil prices are doomed this year, and that the bottom somehow isn’t even in yet. Those who invested in the United States Oil Fund LP (ETF) (USO) on the way down have lost money — a lot.

I believe that after such a precipitous drop in oil prices, there is more room for upside than downside from here. Combine this with the fact that the whole world is short oil in one way or another, and we could see a sharp reversal in oil prices and the USO in the next few weeks.

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Fundamentally, the globe still depends heavily on oil. I don’t believe that demand for it died as fast as prices have recently fallen. This suggests that the all-time high prices were, in fact, a bubble.

Experts say this price depression is due to excess supply, not lack of demand. If so, it should eventually resolve itself.

Technically, I can’t find any USO levels against which I can forecast a bounce. Yet, I still want to take a bullish position in it — namely, I want to use this consensus in negativity to take a contrarian trade with small risk.

I can do this using the options market without the immediate risk of losing funds. The reward is a decent yield as long as USO doesn’t crash 30% lower than current levels.

2 USO ETF Trade Ideas

Options are time-sensitive so I want to set enough time on my trade to better manage the risk. This strategy can be implemented in either of two trades.

  • Trade #1: I sell USO Oct 2016 $5.5/$4.5 credit put spread and collect 13 cents per contract. Max profits would represent a 14% yield on money risked. This opens the downside risk in USO ETF.  To be 100% successful, I need USO to stay above $5.50 by mid October to win. My breakeven point is $5.37. I can suffer a maximum loss if USO falls past both legs of this trade. I can close this at any point between now and the expiration date.
  • Trade #2: I can sell a credit put spread using the Mar 2016 contracts instead of Oct 2016. The USO Mar 2016 $7/$6 credit put spread pays 12 cents per contract. This is my max gain and represents a 13% yield on money risked. For this to be successful, I need USO to stay above $7 per share by mid-March.

We’re still plagued by the potential for negative headlines that could drive USO even lower. But after such a precipitous drop, I am willing to risk a little for a respectable yield.

Neither of these two trades are bullish USO. They simply state that it won’t fall past a certain level. If I were bullish on the USO, I could use some of the premium I collect to buy March or Oct 2016 calls in the USO ETF.

It is important to note that if the Federal Reserve hikes the fed funds rate later this year, it could spark a rally in the U.S. dollar, which would put downside pressure on commodities like oil. This would lessen my odds of success.

One last note about what oil’s problem is: I propose that the problem is neither supply nor demand.

Oil is a rigged market, and there are no current experts who know more than you on the subject of where USO prices will go in the midterm.

This is because we are amid an economic war between OPEC and the U.S. Only OPEC knows where oil prices will go. They are committed to keeping prices depressed so they can increase their market share. OPEC will also kill new entrants into the oil supply markets.

After all is said and done, only the well-capitalized companies are likely to survive. But until that battle abates, prices do not depend on fundamentals. Using the options markets allows me to still participate in this tricky venue with minimal risk.

Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.

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Nicolas Chahine is the managing director of SellSpreads.com.


Article printed from InvestorPlace Media, https://investorplace.com/2016/01/united-states-oil-fund-lp-etf-uso/.

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