With ever-present catalysts to drive the price of the United States Oil Fund (USO), your guess is as good, if not better than mine as to what comes next. But you expect a large price move to make an appearance, as I do, a USO long strangle is a compelling way to position right now.
USO needs a headline driver to instigate a challenge of the August 24 flash crash low or a breakout of three-month range highs. Perceived bullish or bearish drivers out of China are prime suspects and capable of moving the price of oil aggressively in either direction.
Weekly inventory reports, reignited Middle East tensions and a host of other sound bites are also always worthy contenders for being able to muscle USO on its price chart.
At the end of the day, I don’t know which storyline is next to act as a catalyst in USO and provide price fuel for either bulls or bears. But in reviewing the USO price chart, I do feel strongly a large price move in USO stock is very close at hand.
USO ETF Stock Daily Chart
The chart above shows USO stock’s daily movement. From the Aug. 24 flash crash low, which drilled USO stock to all-time-lows, shares have rebounded and been trading more or less in a lateral range the past couple months.
During this period there have been a couple episodes of cheers and jeers from bulls and bears on false breakouts and breakdowns, which ultimately found shares back inside the trading range. Bulls were the first to be disappointed during early October’s failed attempt to breakout above the prior March low and September’s short squeeze high.
Bears were likely miffed in late October as the September and October support around the $14.25 level in USO appeared to fail — only to reverse and find USO moving aggressively higher before being stymied at the March low.
With failed attempts in October for both directional camps and possibly leading to fewer traders now actively looking for a large directional move in USO, oil becomes more likely to score an actual breakdown or breakout.
Given the most recent failure just below the March low I’d say there’s a slight advantage for a breakdown. But truthfully, I’m more in favor of seeing the potential for a large price move as readying — and the type of price action which lends itself to a long strangle position in USO.
From current price levels in USO, I’d estimate that a minimum bearish move to $12 or $12.35 is possible in USO in the next month. That, of course, would represent a test of the Aug. 24 low.
On the upside, a test of the September and October highs of $16.15 to $16.20 would be a minimum price objective in USO.
The real expectation, however, is for a much larger price move in USO to develop over a couple months with bulls riding a new price trend or bears continuing to improve upon 2015’s price chart into 2016.
USO ETF Long Strangle
Options pricing in USO is looking relatively attractive for a long strangle position. Implieds and underlying USO stock volatility have been cheaper at other points in 2015, but they’ve also been also substantially higher.
And with implieds and underlying USO volatility currently in the lower portion of the 2015 range and both trading close to one another, the non-directional volatility strategy is better supported.
Looking at the USO options board and given our price expectations for USO stock, the February $11.5 put / $17 call for 55 cents or cheaper is a good fit and has a solid risk-to-reward profile in conjunction with money management.
On the downside — and we’re not referring to directional price action in USO — I’d set a stop-loss of 50% to reduce the spread’s maximum risk to about 27 or 28 cents.
Ultimately, time is on the trader’s side for the next several weeks. However, time decay and the possibility for further volatility compression are always threats to guard against.
On the upside and the profitable side of either a breakdown or breakout in USO, investors can either take profits or reduce position sizes if oil starts making moves toward either $75 or $25 per barrel.
Disclosure: Investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT
