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Drill for Upside in the Oil Fund

As oil outperforms its fellow commodities, consider put-selling


Wednesday ushered in some impressive liquidation in the commodity space. When the market was at its morning lows, silver, as represented by the iShares Silver Trust ETF (NYSE:SLV) was down 8% while gold, tracked by the SPDR Gold Trust (NYSE:GLD), had fallen 4.3%.

Daily chart of the U.S. Oil Fund (USO)
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Compared to its precious-metal brethren, the United States Oil Fund (NYSE:USO) largely sidestepped the selling frenzy, dropping a mere 1.7% by the end of the day. The current short-term uptrend in the oil patch remains intact, making the last three days of selling an alluring “buy the dip” opportunity. Year-to-date, this ETF is up 7.5%.

Oil prices have been on the rise this year, amid increasing tensions with Iran. Crude prices are now nearing 2011 highs and many analysts expect them to keep on rising.

Those looking for a higher-probability way to participate in rising oil prices should consider selling out-of-the-money puts. Short puts are a good match for the USO since its cheaper share price keeps the margin requirement quite low.

Typically, the amount of margin required to cover the naked-put risk comes out to around 10% to 20% of the stock price. This may vary depending on individual broker requirements. You will want to confirm with your broker how much stock or cash will need to be earmarked to fulfill the requirements of this trade.

Currently, the USO April 38 puts can be sold for around 73 cents per contract. Think of this short put as a bet that the USO won’t drop to $38 by April expiration (that’s a fall of 7.7% from its current price of $41.17). Breakeven on the position is even lower, at $37.27, or the strike price less the premium collected.

If the trade goes in your favor and USO stays put, moves higher, or even moves slightly lower, the April 38 put will expire worthless at expiration on April 20. At this point, you will realize the maximum potential profit and keep the initial premium ($73 per contract or so) received at trade inception.

By selling the put, you obligate yourself to buy USO stock at $38 if the shares are put to you. In the event you’re a willing buyer at this price, you could ride the option to expiration and allow assignment if the ETF does fall beneath $38.

As of this writing, Tyler Craig did not hold a position in USO.

Article printed from InvestorPlace Media,

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