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Profit Amid Crude’s Awakening

We struck black gold once, so let's try another USO butterfly


While 2012 will go down in history as yet another favorable year for stocks and a furtherance of the cyclical bull market that took root in early 2009, it most certainly won’t be remembered as a banner year for many commodities.

Compared to the S&P 500 Index’s respectable 13.3% run, the SPDR Gold Trust‘s (NYSE:GLD) yearly gain of 3.9% is far from impressive. But, hey, at least it finished in the green. Poor ol’ crude oil came limping across the finish line, ending the year down 7%. What’s worse, those who bought and held the United States Oil Fund (NYSE:USO) — by far the most liquid proxy for crude oil for stock traders — suffered a 12.4% loss on the year.

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While falling crude prices might be widely applauded by consumers, it’s not a positive development for owners of energy stocks. Perhaps due in part to weakening crude oil, the Energy Select Sector SPDR (NYSE:XLE) fund was the second-worst-performing sector last year after utilities. As illustrated in the accompanying graphic showing the absolute sector returns for 2012, the Energy SPDR finished up 5.6%, which was only slightly better than the 5.21% gain by the Utilities Select Sector SPDR (NYSE:XLU).

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Fortunately for oil bulls, the behavior of black gold has been quite a bit more constructive of late. The energy sector is now running in the middle of the pack for 2013, holding fifth place among the nine Select Sector SPDRs.

What’s more, the price chart of USO is looking more bullish than at any time over the past four months, with an uptrend now firmly in place above rising 20- and 50-day moving averages.

On our last visit to the oil patch in early December, we highlighted the potential for a bullish breakout and suggested entering a January 32 x 34 x 36 call butterfly for 50 cents on USO. After a minor detour lower, USO has now risen into the heart of the fly’s profit zone, causing the value of the position to rise from 50 cents to $1.17. With a mere 11 days remaining until January expiration, the fly should continue to rack up additional profits if USO can remain around the $34 level.

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In light of the recent upturn in oil along with the success of the January fly, traders might consider entering another bullish call butterfly for February. A realistic price target for USO over the next month is $35, so we will set up the fly centered around the 35 strike call option.

The position is entered by buying one Feb 33 call, selling two Feb 35 calls and buying one Feb 37 call for a net debit of 62 cents or better. The accompanying risk graph displays the potential profit and loss of the position. The max loss is limited to the initial 62 cents paid and will be incurred if USO sits below $33 or above $37 at February expiration. The max reward is $1.38 and will be captured if USO sits right in the heart of the fly at $35.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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