I wrote back on February 27th, 2012 that I was taking profits in United States Oil Fund (USO) and was bearish on oil in this article after being a bull on August 28th, 2011. Prompt contract in crude oil finished that day at $109.77, with USO at $41.18, and has not seen that level since. It closed on June 1st, 2012 at $83.23, with USO at $31.43. The timing of the high in crude in tandem with my taking profits was good fortune, but I had thought we could see slightly higher prices, since I did not get massively bearish at all.
I simply moved away from the trading area in crude since and traded other instruments. I am starting to warm back up to the idea of trading crude again from a long-term perspective.
As I briefly touched upon back in February, the economic concerns have started to reach the mainstream media, and are seen in some of the economic numbers. Is this over? Not by any means, and it could be looking like the summer of 2012 is the summer of 2007. However, is that a high probability event? It is not in my opinion, but the potential is definitely there.
So with that being said, why in the world would I want to become a crude bull via USO? Simply because it has greater growth potential than other trading ideas right now. Some of the major oil plays could actually be better (if you think of dividend yield in tandem with option enhancement yield strategies), but my focus is on structuring long-term bullish trades in crude via USO.
Since USO is exposed to contango, I always try to look at lower risk entries for the ETF versus exact crude prices, because January 2014 Crude Oil is priced at $85.48 or 2.7% higher. Not much higher, mind you, but the contango could easily get bigger.
At this current point of time, I really like being bullish on crude in the $65-70 level via USO as a long-term trade with some way of exposing myself to being a crude bull at $83. The trade I like at this time would be to sell the January 2014 $25 puts for $2.30 (bid as of June 1st, 2012 close) or $230 each. $25 for USO would be the current equivalent of $66 crude oil, which is within my long-term comfort level.
However, I want to get higher bullish exposure to crude without really jeopardizing my long-term entry cost level. The next step in the trade is to use the $2.30 or $230 net credit received for selling the January 2014 $25 strike puts to buy a call spread.
The $32-$38 January 2014 call spread could have been obtained for $2.30 during trading on June 1st, 2012. This would give bullish exposure immediately at the money with no out of pocket cost. USO at the $38 level would be the current equivalent of $100 crude oil.
The trade structure discussed above does have risk, as one would be assigned long shares in USO at $25 per share or at the current crude oil equivalent of $66. If contango were to grow larger in crude oil and prices were to stay below $66, then the position would have a loss. The worst case scenario is that crude oil futures go to $0 (I would say that is 99.999% not likely to occur) and the trade would lose $25 per share.
The potential upside in the trade is quite large if the puts expire worthless and USO is also above $38 by January 2014 expiration. Profits on the trade would currently be limited at $8.30 per trade against a maximum value at risk of $25. This would be a return of 33% through January 2014. If oil does, in the short term, run back above $105, then the trade could be exited at good profits (but not 33%) and closed out similar to the last trade written about back in August & February.
I extended the time of this trade out until January 2014 to give the trade room to breath and increase the probabilities of success due to the overall better entries and exits. I would not recommend this being your first and last entry in crude for the bullish side, but to leave the ability to enter into another 2 bullish trades in the event we race down to the $60 level in crude before the year is out. One could then structure another very similar trade, but have an entry in crude in the $35-$40 level (2009 area).
Disclosure: Long USO via bullish delta option plays.