For anyone that has to drive a car to get around, going to the gas pump lately can be dreadful. Even as technological advances in the auto industry to make cars get better gas mileage continue to see positive results, the results are not enough to keep up with the pace of rising oil and gas prices. Oil also has a wide variety of uses besides being converted into gasoline; Oil is needed for make-up, dyes, paint, plastics and fertilizers to name a few. Here in the Saint Louis area where I reside, the average price is $3.42 a gallon. While this may seem low compared to those of you who live on the east and west coasts, believe me this is still expensive compared to the average price of gas last year in Saint Louis. In the world of investing there will often be many times where you will get to participate in "the trend" whether upside or downside. Sometimes the trend can be short in time and at other times this trend can last for a while.
Whether you believe it or not that the price of oil will continue to increase before summer is here, I believe one's portfolio should have some exposure to oil. In my options portfolio I generally keep 10% allocated toward an oil play. Some investors may choose a higher percent allocation toward oil and some investors none or less than 10%
Now for the million dollar question, how high can oil go? Will we see $5 a dollar national average for gasoline? I wish I had those answers for you, but if I did we could enjoy a successful options strategy and fill up our gas tanks with the profit. Today on March 1, 2012 Brent crude traded above $128 and West Texas Intermediate WTI traded above $110 at one point. Since February 13, 2012 Oil has been trading upward before cooling off the last two days. There are times the market gives us cues to when oil might selloff and these selloffs can provide opportunities to make money in oil whether your bullish or bearish. From February 13, 2012 to February 24, 2012 oil was in a bullish trend until it broke above the upper Bollinger bands; at same time negative media pressure and possible opening of Strategic Petroleum Reserve. This leads to a two day sell off in oil before a strong gain on March 1, 2012 because of a possible explosion of an oil pipeline line in Saudi Arabia (pipeline explosion not 100% confirmed). The cues were laid out and the technical sell signals combined with negative media attention, and a selloff is due.
I would use these sell offs in oil as an opportunity to be bullish on oil as we get closer to the summer. The reported pipeline explosion in Saudi Arabia is nothing new to the oil markets and one cannot discount the possibility for a "real" pipeline explosion, geopolitical unrest, Iran tensions or any other events that can cause oil to shoot higher. There are many different ways to play oil using options, but I am going to stick to one oil option play for now. If you are not familiar with the United States Oil Fund (USO), this ETF tracks the spot price for WTI crude. The United States Oil Fund is a play for higher oil and this ETF also invests in futures contracts on crude oil, natural gas and heating oil.
Trade Idea: Buy USO May Calls
If you read any of my past articles you will know that I'm generally conservative on my option trades. But, when I make trades on commodities ( oil, gold and silver for example) I tend to be a little more aggressive by buying in the money calls or just buying slightly out of the money calls. After the two day selloff in oil, I bought the May $42 call in USO for $1.90 or (1.90 x 100 = $190). I am not going to recommend a specific strike, but the further in the money you go and these calls start to get expensive. Sticking to my 10% rule that I have allocated toward oil and since I am being a little more aggressive than usual. I decided to keep things simple/speculative and purchased one call for now, since oil can be quite volatile at times. With the volatility of oil you want to have a game plan in place before you enter a commodity trade. If you are a newer investor, here some reasons for a game plan in one of my previous articles.
Looking at this graph in the United States Oil Fund, I am only looking for this trade to be a short term speculative trade in oil. Even with these unfounded reports of pipeline explosions, (this shows how much this one report can rock the oil market) and with increasing political pressure the United States Oil Fund could slip. In the short term I believe the trend is for oil to go higher because of continued economic growth, unusually high winter temperatures and more people entering the job market (just to name a few). For now I am content with only being able to make a small profit, but I will continue to watch the United States Oil Fund on dips.
Thanks for reading and Good Luck.
Disclosure: I am long USO.