Betting on options in commodity-based ETF and ETN products can be tricky, and when it comes to energy, the risk can be even greater. However, options on ETFs and ETNs are easier than trying to track options on the underlying commodity prices.
Buying downside protection via put options in the United States Oil Fund (USO) is now cheap as Nymex WTI crude prices have risen above $85 per barrel. In fact, they are now up over $1.80 per barrel, clearing the $86.50 hurdle.
USO puts can be used here to speculate against a further rise in oil or to help lock in some gains in the sector with at least some downside protection.
The USO is up at $42. USO April 42 Calls (USO 100417C00042000) cost 78 cents per contract, and the USO April 41 Puts (USO 100417P00041000) cost 43 cents. While a larger move is actually needed to break-even on the puts than the calls, the puts actually look like the better bet.
The USO has been subject to steady share price erosion due to the notion that it rolls between front-month contracts farther out, and this has been repeatedly documented. There are also commodity limits still front and center from the Commodity Futures Trading Commission (CFTC). And then there is the notion that we are now at near-term highs in oil.
For the calls to work out, oil would have to keep hitting new near-term highs, and the call for $90 oil would need to be louder. This would also mean that the recent OPEC and non-OPEC minister agreements of $70 to $80 oil being appropriate for years ahead is as wrong as ever.
The thesis behind the put trade is not one of massive recovery nor of massive U.S. dollar devaluation. It is based on the notion that markets should be reaching a form of equilibrium after the strong moves we have seen of late. That should be true of stocks, currencies and even commodities.
Still, this is a direction-based call, and the theory of equilibrium really only holds up for a short period of time. Don’t expect any offshore drilling ban-lifts to add much to supply any time soon. That is only going to matter long-term, and some oil executives feel that it just makes up for other bans in place now or that will be put in place.
So this is a bet against the crude rally, and one with a fairly low premium on the front-month contract.
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