The Market’s in for a Crude Awakening

by Tyler Craig | June 18, 2013 8:37 am

While the equities market continues to grapple with the implications of the much-talked-about Fed tapering, not all areas of the financial playground have been affected equally. Sure, interest-rate-sensitive areas like utilities and REITS have been taken out behind the proverbial woodshed. At the same time, foreign stocks — particularly those in the emerging-markets space[1] — have suffered dramatically more than here in the U.S.

Interestingly, while the broader commodities market hasn’t staged any major moves of late, crude oil is approaching a pivotal juncture. Its 6.4% gain so far in June has lifted crude futures to just under $98 a barrel — a zone which has acted as impenetrable resistance since mid-2012.


To see how oil’s performance has fared vs. the commodity complex at large, we can look at a ratio of the United States Oil Fund (USO[3]) vs. the Powershares DB Commodity Index Fund (DBC[4]) — an ETF that follows a smattering of commodities, from crude oil and natural gas to gold and silver to a handful of agricultural commodities like corn, wheat and soybeans. Although USO has been outperforming DBC throughout 2013, its relative strength recently accelerated to a new one-year high. At the same time, we’ve seen the price of USO (shown in the top panel) breakout above a multimonth trend line.


If we drill down further into the candlestick chart of USO, an inverted head-and-shoulders pattern appears to have recently completed. Typically, this setup is pitched as a bottoming pattern developing at the end of downtrend. However, the inverted head and shoulders also can come in the form of a continuation pattern, appearing in the midst of an ongoing uptrend or consolidation. The formation of the right shoulder and subsequent break of the neckline confirms that the bulls have wrested control in USO during the past month.

Further bolstering the bulls’ resolve in this popular oil ETF is the fact that its comparative relative strength (bottom panel) recently reversed into an uptrend, showing it is once again outperforming the S&P 500 Index.


Traders looking for crude oil to finally break above the previously mentioned resistance at $98 could sell the August 33 puts on USO for 55 cents or better. The profit is limited to the initial 55 cents received and will be captured provided USO remains above $33 by August expiration.

To reduce the risk, consider exiting if USO breaks back below the right shoulder around $32.50. Using a risk graph (not shown), your estimated loss would be about $100.

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

  1. particularly those in the emerging-markets space:
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  3. USO:
  4. DBC:
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