Is it time to go long in oil and buy the United States Oil Fund LP (USO)? It’s looking more and more that way, but remember to play it smart and don’t expect your broker to take you out for dinner.
Let me explain.
Black gold and USO have come a long ways from 2008 when Mr. Market (read: Goldman Sachs) was trumpeting a “super-spike” scenario, peak oil and slapping a price target of $200 a barrel on the commodity.
Now, all the rage is to present equally convincing bearish arguments with targets of $20 in oil and what would amount to a price of around $5 to $6 in USO as a loose estimate.
For their part, Goldman was early in mid-September when it declared its bearish forecast. Oil has dropped some 40% and USO has cratered from about $14.50 to $8. Of course, if you’ve turned on news you’re well aware of the chorus of doom and gloom for the oil ETF.
A month ago, with oil nearer to its lows than not, USO was maligned by association as Morgan Stanley announced its own price target of $20 for oil.
Morgan Stanley proffered “a global glut may have pushed oil prices under $60 a barrel, but the difference between $35 and $55 is primarily the U.S. dollar,” according to the report.
As for the price target, Morgan Stanley went on to say continued strength in the greenback could find oil between $20 and $25 because of the commodity’s leverage to the dollar.
Okay, so with the dollar hammered in recent days to four-month lows (but at the same time oil also down 7% to 10%), is now the time to buy USO?
USO Stock Daily Chart
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The approximate 60% haircut in USO since 2015, of course, fails to even consider the go-go period of peak oil circa 2008 when all-time-highs were set. If we were to factor in that descent, USO has lost 93% of its value!
There is good news in that same price action though. Well, there’s some good news. Of late, shares of USO have formed a three-week double-bottom pattern on heavy, but dissipating volume.
Whether this marks the bottom for USO isn’t guaranteed, and more than likely, it won’t. Call me a cynic, but Mr. Market probably won’t allow it. Having said that, USO also isn’t going to zero anytime soon either.
The sad truth is while many companies in the oil patch could face bankruptcy, the same can’t be said about oil and in fact, those same failures would ultimately work to USO’s advantage.
A Bullish Strategy in USO
For bullish traders looking to initiate a position and accumulate on weakness, position with a long call, and do so for no cost! That’s because implieds now trade at historic extremes in USO, so there is the reverse fence strategy to consider.
If you’re unfamiliar, the reverse fence sells an out-of-the-money put, and hence allows the bullish USO trader to accumulate on weakness.
To complete the USO reverse fence, the trader also purchases a different strike, long call in the same contract month. The long USO call is what keeps the trader long if USO rallies.
And because the USO call is financed by the put sale, either partially or completely, the trader is making a better spread position in a high volatility environment and where we might want to reduce unwanted volatility and time decay risks.
One reverse fence in USO, which is setting up for nearly even money is the July $6.5 put/$10 call.
With the call priced for 55 cents and the put trading mid-market at 53 cents, this USO bull is essentially willing to buy USO for $6.50 vs. today’s $8 price, but will also be positioned long above $10 should USO rally.
Investment accounts under Christopher Tyler’s management currently own positions in USO and its derivatives.
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. For additional market insights and related musings, follow Chris on Twitter @Options_CAT
