Crude oil is experiencing one of its largest down days since its rousing recovery began in mid-February. The king of oil exchange-traded funds — The United States Oil Fund (USO) — is down over 3% in Monday’s afternoon trading.
Traders familiar with the mean reverting nature of asset prices are altogether unsurprised at Monday’s downdraft. Given the gargantuan gains in the oil patch a pullback was inevitable.
If you’re a believer in the ongoing USO rebound, any and all dips should be viewed as future profit generators. If the much anticipated bottom has actually formed in crude oil and February’s lows hold for months to come, then dips are now buyable in black gold.
While it’s always difficult to discern exactly how much a stock will pullback before buyers rush in to halt the descent, technical analysis does provide a few time-tested tools to make some educated guesses.
One oft-watched metric known to be a gathering ground for dip buyers is the moving average. The 20- and 50-day MA in particular are hot spots for support to materialize. As shown in the accompanying chart, both averages are sitting at $9.17. Should the oil pullback persist, the $9.17 zone is as logical an area for USO to bounce as any.
Click to Enlarge
One more support identifying tool is the Fibonacci retracement, which simply measures the magnitude of a stock’s descent relative to its prior ascent.
For example, USO has rallied from $7.67 (Feb 11 low) to $10.29 (March 11 high) over the past month.
If we draw a Fib retracement from the low to the high we discover a 38.2% retracement of the advance would take USO down to $9.28. This is one of the first areas where buyers often congregate to halt the decline and kickoff a new advance.
Drill for Cash in USO
Regardless of where support ends up materializing, traders have a number of profit-generating strategies beckoning in the options market. And USO options are the poster child for liquidity, making them a cinch to trade.
If you’re willing to wager the oil ETF remains above the $9 level for the month ahead, sell the April $9 put for 25 cents. The max reward is limited to the initial 25 cents and will be captured if the put expires out-of-the-money at expiration.
The margin requirement (i.e. the amount of money your broker will tie up as collateral for the trade) should come in somewhere around $100 due to the low price tag of USO, giving the trade a fantastic return on investment.
By selling the put you obligate yourself to buy 100 shares of USO at $9 if the put sits in-the-money at April expiration.
At the time of this writing Tyler Craig owned short calls and puts on USO.
