After lying dormant for months, the volatility beast has finally returned to wreak havoc in the oil pits. The United States Oil Fund LP (ETF) (NYSEARCA:USO), king of all oil-based ETFs, suffered a 5.3% drubbing on Monday, falling to a three-month low on substantial volume.
Let’s not mince words. It was ugly.
Joining USO in the hair-raising plunge were energy stocks of all stripes. Some of the hardest-hit names include Murphy Oil Corporation (NYSE:MUR) and Devon Energy Corp (NYSE:DVN) which slipped 6.7% and 6.5%, respectively. Even the big boys joined the sell-fest. ConocoPhillips (NYSE:COP) fell 3.8% while Exxon Mobil Corporation (NYSE:XOM) dropped 1.8%.
Support levels gave way across the land as sellers pressed their advantage all the way to the closing bell.
But, do you know who’s celebrating the newfound volatility in USO? Option sellers.
The oil fund had become boring, really boring. Over the past quarter, USO has been behaving more like an old consumer staple stock. As a result, the implied volatility for USO options has been more depressed than Hillary Clinton supporters after the election. With flaccid premiums, strategies like covered calls and naked puts have lacked any kind of profit-giving pizzazz of late.
And that is what makes Monday a gift from the market gods.
See, implied volatility ramped all day long as investor demand for options soared. The implied volatility rank quickly ascended from the low single digits to 25% by day’s end. Here’s to hoping we see some downside follow through in oil prices tomorrow. Further bloodshed should propel implied vol even higher.
And that’ll make option premiums even riper for the picking.
Embrace the Fear, Queue up USO Puts
There are two ways to view Monday’s oil spill. Either it’s the beginning of a prolonged downturn, or it’s a dip to be bought.
At this point, I favor the latter view. And that means sooner than later it will be time to strike with short puts in USO. Selling out-of-the-money puts lines up perfectly with the dip buying mentality. Not to mention it capitalizes on the now juiced up option premiums.
Sell the USO Apr $10 puts for 20 to 25 cents.
To further increase your odds of success, consider scaling in. That is, sell a portion of the desired naked puts now, then wait to see if further selling increases the value of the $10 strike puts to 30 cents or 40 cents. At that point, you could sell the rest of your naked puts at a higher credit. This tactic will increase the average credit received, which reduces your expiration breakeven price.
The max reward is limited to the initial credit and will be pocketed if the USO ETF sits above $10 at expiration. By selling the put, you are obligating yourself to buy 100 shares of USO for each contract sold if the fund sits below $10 at expiration.
As of this writing, Tyler Craig held neutral option positions in XOM.