An ETF Options Strategy To Carry Forward Low Gas Prices

I've been thinking alot about Bespoke Investment Group's recent Seeking Alpha article on how to "Lock-In Low Gas Prices." It's an intriguing idea that I want to un-pack with a real strategy that I'm thinking about using based it.

First, someone had an insightful comment to Bespoke's article that the ETF they proposed using, UGA, traded relatively low volume and therefor was unattractive on that basis. I would propose using the USO instead for two reasons. One, it trades 13,000,000 shares average daily volume compared to only 45,000 shares for UGA. Second, the USO and UGA charts going back over the last year virtually overlap each other on a percentage gain and loss basis anyway.

Here's my strategy. Since most experts say that oil is going even lower before it heads back up, I'm picking a price target for the USO about 20% lower than it is today - around $38. I will sell a USO January 30 put for around $120. I will pocket this premium while I wait for it to go down - what a deal. If it makes it below $30 by expiration day (the 3rd Friday in January), I will find myself long 100 shares of USO at $30 - a $3,000 investment. If it doesn't get that low, I will just sell another put 20% lower and see if I get assigned the contract next month.

Once I get assigned and find myself long 100 shares of USO, I will sell a call around 30% over the current share price month to month to pocket another premium (around $100 per month as I do the math based on today's option chains). If my call ever gets exercised, I will have taken the emotion out of the decision as to how long to hedge today's lower gas prices.

Got a better idea? Let me hear it below...

Disclosure: No Positions Held

Comments

[kurt walter:]

Why not buy both long term calls and long term puts on USO. Then just hope oil prices don't flat line?

2008 Dec 14 06:45 PM

[Trading Alpha:]

Why not just go long the USO and lock in $1.60 gasoline. If oil goes lower buy some more. If oil goes higher you have hedged your future energy needs. $45 oil is like 4.5% fixed rate mortgages in 2003 - back the truck up.

2008 Dec 14 11:33 PM

[billb123:]

The problem here is tracking error. These leveraged and futures based ETFs aim to replicate the DAILY movement of the underlying. Once you start holding for longer periods, the tracking error inevitably gets you. So your "lock in" is not actually a lock.

However, the strategy that the author presents MAY offer some relief against the error in the form of time premium. Of course, the author is at risk of owning the underlying. Due to oils volatility, writing calls is probably not a viable long term strategy either. Imagine this scenario. You're assigned today, you write a call. No problem. Over the next month oil drops another 30%. A call above your assignment price is going to be worthless, so your only two options are to write a call that may lock in a loss or hold the underlying and pray. Naturally, you get some kick back at the pump, but I'm trying point out some nuances associated with this approach.

2008 Dec 15 07:48 AM

[Trading Alpha:]

If one looks at the run-up from 1/1/07 to the peak in July 2008 the increase in oil and the USO was 145% and 128%. Oil is now 31% of its peak as is the USO. Any tracking error does not appear to be significant.

2008 Dec 15 10:08 PM

[Kunst:]

Take a look at DTO, the double-inverse crude oil ETN. It is up 400+% in the last six months. DXO, the double-long equivalent, is down ~87% (currently around $3), while OIL/USO are down ~67% in the same time.

I am long DXO. I think the reward opportunities far outweigh the risks at this point. Even if oil goes down some more, I don't see how it can fail to go up over time.

2008 Dec 16 01:50 AM