Oil Barrels Ahead On A Fast-Moving Train Of Speculation - VIX

by: Daniel Sckolnik

"Do the difficult things while they are easy and do the great things while they are small. A journey of a thousand miles must begin with a single step." - Lao Tzu

At the rate things are going, it seems likely that oil won't find itself below the $100 per barrel price level anytime soon. And, while you can blame Iran for being the straw that stirs the current brew of high crude prices, it is clearly the speculators who are driving the prices up to the highest levels in over nine months.

Crude oil gained 6% on the week, ending Friday at just a notch shy of $110 per barrel. It is obvious that there hasn't been a sudden and urgent increase in demand for the stuff, as growth has been fairly minimal on both the domestic and international front. The source of movement of the commodity has essentially emanated from the machinations within the political arena, not the increased demands of the manufacturing sector. The jacked-up prices can be traced to the place where speculators thrive, as they are essentially betting that the threat of a broken supply chain will be all it takes to keep the price near or above its current level, for the short term, anyway.

The problem of the moment revolves around a string of events resulting from the U.S. and the EU attempting to rein in Iran's nuclear intentions. The tool of choice for the allies has been a new round of sanctions, including the freezing of Iranian assets by U.S. banks and an Iranian oil embargo promised by the EU. The Iranian government has responded predictably, rattling its sabers and swearing to block the crucial oil shipping lanes that pass through the Straight of Hormuz.

As even the casual observer of the Middle East can attest, it doesn't take a whole lot of threats and counter-threats swirling around the region to send the cost of crude high and higher. And, with a crucial round of elections scheduled for next week in Iran, the stage is set for amplified hostilities, even if it remains in the realm of verbal-sparring.

Toss an ever-edgy Israel into the mix, and the global markets cannot help but be impacted by fear and doubt. What is interesting, at least at the moment, is that the only market that seems to be significantly impacted is the energy market. True, the U.S. equity market has admittedly slowed down its Bull-mentum the last four trading sessions, though both the Dow Jones Industrial Average (NYSEARCA:DIA) and the S&P 500 Index (NYSEARCA:SPY) gained 0.3% during the holiday-shortened week.

The SPX is currently wrestling with the 1,370 line, and, if it can counter the wave of resistance that it has encountered over the course of the last week, it may break through the level of its 2011 highs and proceed to open the throttle on the Bull Train that's been proceeding consistently so far this year.

However, should the saber-rattling escalate to more concrete hostilities, all bets are off, as a higher crude would stamp out whatever growth the U.S. might be experiencing, and fear in the market would bring out the bears, who have begrudgingly hibernated so far this year.

What the Periscope Sees

The VIX (Chicago Board Options Exchange Market Volatility Index) has been trading toward the lower end of its12-month range, indicating that investors and traders have been feeling a little bit calmer about the market. Risk-taking has started to replace fear somewhat, and that is reflected in the VIX. A lot of that change has occurred due to the perceived shift in the eurozone's direction, and whether that viewpoint turns out to be an accurate one or not, the focus of investors has certainly been upon the other side of the Atlantic.

Iran simply has not been predominant upon Wall Street's radar, at least up until now.

What the current set of circumstances provides, then, is an opportunity to catch up on some portfolio insurance via the VIX, at what is a relatively low price. The explosive nature of the VIX, which can shoot up 20% or more within a few days if the market starts to tank, makes it a valuable tool for protecting yourself against sharp, downside moves.

You can't trade the VIX directly, but you can use one of the various ETFs that track the Volatility Index. The VXX (iPath S&P 500 VIX Short-Term Futures ETN), which tracks the near-term futures, is a good vehicle for the job, as it is one of the most liquid of the VIX-based ETFs. The VXZ (iPath S&P 500 VIX Mid-Term Futures ETN) can also be used to similar effect, though it has a slightly less explosive nature than the VXX, as it tracks the VIX mid-term futures.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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