“Headline Risk.”

It’s a term I recently heard coined on CNBC in reference to the stock market. But it can be equally applied to what is going on with Crude oil prices at this time.

Headlines are driving prices. Traders are liquidating long crude positions not because the demand picture has changed, not because the supply picture has changed, not because of any traditional drivers of crude prices. Traders are liquidating over uncertainty.

When in doubt, get out.

The European debt crisis, the North Korean situation, long term effects of the Gulf Oil Spill; Traders don’t know how these will affect oil prices. So they exit. And like a self fulfilling prophesy, the market seems to price in a worst case scenario before any real effect on supply and/or demand even takes place.

That appears to be what has happened, or is happening right now with crude prices.

Trading the Headlines

In old Western movies, such as Gunfight at OK Corral, it was often portrayed that the fastest gun won the gunfight. But real history tells a different story. It was more often the steadiest hand, not the fastest, that prevailed in a shootout. The cowboy that drew fast, shot fast and missed would be left at the mercy of the gunfighter that slowly aimed and squeezed off a targeted shot.

 

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Crude traders in liquidation mode as of late are like the fast gunfighters. They are reacting quickly to an uncertain situation. They are responding emotionally to headlines. Both markets and gunfighters in this mode are erratic and dangerous and it’s best to stay out of their way.

However, at a certain level, they use up all their bullets.

And that is where you, the option seller, can come in, slowly aim, and squeeze off your shot.

How Low is Too Low?

We are not publishing an article with the intention of calling the low in the crude market or predicting what will happen in Europe. Nobody, not even Buffet or Soros, knows the future. We do write with the viewpoint that crude prices have already priced in a bad European scenario.

We are now left with a market that is substantially oversold, heading in to what has traditionally been peak demand season.

That is not to say that crude prices cannot continue to decline. They can, especially if the Euro continues to weaken. However, it is our opinion that with crude prices having already fallen by more than 25% during the month of May heading into peak demand season for petroleum, selling pressure will now begin running into some headwinds. Despite the threat of European defaults, the US economy remains on the upswing. Housing prices are rising, gasoline prices have fallen, interest rates are at record lows. The US dollar is very strong, meaning goods and services (imported from overseas) cost less. It is a good time to be a US consumer.

Checking the Calendar

All of this suggests that this year’s travel season will show a substantial improvement over 2009. AAA already projects travel over the Memorial Day weekend to be up 5.4% over 2009 – potentially a sign of things to come.

It is our opinion that the market is probably overshooting the downside and as panic selling subsides, seasonal demand and the relatively low price of gasoline will begin to draw value buyers back to the energy markets.

Oil prices have collapsed right before the start of driving season. I cannot remember another time this has happened. And while we in the market fret over the long term implications of European sovereign debt, the average US consumer is wondering where to go on vacation this year, Ocean City or Lake Chataqua.

We are not suggesting that the low in oil was made this week. What we are suggesting is that oil in the mid 60’s looks like a solid long term value, especially considering the time of year.

Pulling the Trigger

However, not willing to buy oil futures and risk a further downside, we’ll take the cowards way out and simply sell puts in the general vicinity of $45 (strike price) and collect premiums at that level. European crisis or not, we do not see oil prices going to $45 per barrel, at least not in the next 4 months.

By collecting premium at these levels, the options will expire worthless as long as oil is anywhere above $45 per barrel at expiration day.

With the sun coming out for the US consumer, that’s a bet we’re willing to take, headlines or not.

We will be working closely with clients over the next 30 days on the positioning of this trade.

To learn more about selling options in a commodities portfolio, be sure to request your Free Option Seller Investor Kit at OptionSellers.com.