Trading Oil with Options

In an article posted recently, Three Ways To Play The Black Stuff, the choices in trading the oil market were covered, and ideas put forward as to how best to take advantage of leverage. The issue of properly funded accounts, in regard to capitalization that allows any potential trade to be taken, is an important point to understand in why these articles were written. Most traders are hedging their longer-term portfolios, and as such do not always have well enough capitalized trading accounts to hold near-term trades that turn into longer-term investments.

We hear the comment, "I cannot trade contract "X", it's too expensive," and while that might be true in its purest form, there is always a work-around in the global traded market arena. As global traders, we need to always be aware that there are other markets that have the ability to influence our forex, equity, and commodity positions. We should be always looking to take advantage of them, because that is what the new market-place was built for; maximizing both time and leverage.

Following on from the article on trading oil, on Monday we had the perfect example that turned into a perfect signal from our Global Options Corner service. Attention was drawn while watching the U.S. dollar and equities to the potential move in crude oil. The biggest problem with this for some retail traders is that crude is quite expensive to trade.

For every dollar the price of crude oil moves, the cost to be in the game is $1,000 per contract. There is a mini contract option, and that costs $500 per contract for every dollar moved. With a $4 stop, it's going to be at least a $2,000 commitment in premium on a mini contract.

The new generation of global trader is already invested in stocks, bonds, and Mutual fund accounts; the trading arena that they work in is to hedge potential portfolio losses and to add to portfolio gains, with a percentage of their overall portfolio value in a trading account. As such, the leverage availability in trading is a key decision in what vehicle is used to monetize market moves.

There are a couple of alternatives to a crude oil contract. Going short the Usd/Cad is a play that works the weak Usd, but if you are a technical trader you may not get the same technical trigger that the oil market flashed, on the same time-frame.

There are ETFs such as USO, and other broad-based commodity ETFs like the DBC (PowerShares DB Commodity Index Tracking Fund), which offer a way to reap gains from the commodity markets as a whole. These can be great, but they offer no leverage, and contain other assets outside of crude oil in them. You may be buying oil futures, drilling companies, and a range of other sectors.

The easiest use of affordable leverage and time, was buying a $80 strike price, December 09 call option. The value was $1.30, and the contract therefore cost $130, plus commission. Crude was just below $78 at the time the signal triggered, and left nearly six weeks for it to reach the target price.

The detail of the signal was not concerned solely with reaching the strike price in quick time, it was a directional play that had the benefit of paying the premium to have time to unfold. Non-options traders may have the idea that it is an all or nothing game, but in reality it is very much like forex in the fact that it's making good use of leverage.

Returns are super-charged, much in the same way currency trading allows, with the benefit that the premium paid is where the pain ends, if the trade reverses the signal. The real kicker, is that we then have six weeks to reach our target, it is far from all or nothing, as in a dead stop that closes a trade, limits damage, and then is finished. No second chance happens in the spot market.

The signal had no need to be concerned about the Greeks, Theta, Delta or Alpha. After the initial analysis, it was a straight play on direction and leveraged time. Two hours later, oil hit the $80 area, and the signal flashed to close the option at $4.25; a $425 return on the one option contract, which cost initially $130 plus commission to open.

As a global trader, we spend time correlating different markets, and reviewing their impact on currency movement. With the TheLFB’s Global Options Signal service it is really easy to leverage time, reward, and to also limit risk within the global arena that feels very much like home to the new generation of market traders. Invest in stocks and bonds, and trade the global markets.

Disclosure: No positions

Comments

[Ferdinand E...:]

Someone told me that somewhere a moron reviewed my finance book and gave it an F minus because I had made an easy subject complicated. That fool was right if he believed that options and futures are easy, and nobody knows that better than my good self. As a result instead of grading this article, I think I shall suggest
that this author should visit his local library and see if they have my book. There is an easier way to discuss futures and options than above.

Nov 11 09:57 AM

[Brandon2009:]

Gosh, I thought it was pretty clear. How much more simplicity does one need??

Good article.

Nov 11 12:39 PM

[The LFB:]

Thanks Brandon, agreed. Trading options and futures is easy, planning the potential, limiting exposure, and capping expectancy is the hard part for most. So, we will stick to our 30 years of trade desk knowledge, that has stood us in good stead, and do the hard part; planning the trade. This is not a complicated market, the expectancy of those not educated in the arena they trade is what makes it complicated.

Nov 12 06:45 AM

[The LFB:]

With the greatest respect Prof. Banks to your esteemed career that is very impressive, there is a huge void between the academic side of the market, and the traded side of the market. Those who can, trade. Those who do not, write. There are some who do both, and they tend to be the ones whose trading is simple, and writing is clear. Academics and trading do not mix, and as can be seen in the initial comment to the article, the academic view is sometimes held on a lofty perch. This ‘aint Grandpa’s market, as some would say.

Nov 12 06:54 AM