Crude oil’s precipitous drop from its June highs has yet to show signs of abating. The U.S. oil benchmark, West Texas Intermediate (WTI), is down over 3% again today following Monday’s downside move.
Now trading below $50, oil has moved to a new five and one-half year low, a move estimated to save the average American over $1400 annually and bolster consumer discretionary spending.
Continued strength in the USD and OPEC’s refusal to cut production would lead me to believe oil has room to move to $45 or even lower.
Saudi Arabia became engaged in a price war in the oil markets in 1985, leading the price of the commodity to collapse. Similar to today, in 1985, the US was fighting to break out of a recession and high unemployment. The collapse of oil prices is credited by some as having helped end the recession of the early 1980s.
Some equity options traders I know have been looking to play oil by shorting domestic oil companies, as fracking operations become significantly less viable under $70/barrel and completely unprofitable below $40/barrel.
I prefer to trade the United States Oil ETF (NYSE: USO, $18.30), as it tracks the underlying commodity relatively well on a percentage basis. USO equity options also require significantly less capital than the futures.
The USO Feb 18.5 Straddle is trading $2.65, implying a move of this amount in either direction by February expiration ($15.85 to the downside, $21.15 to the upside).
My Trade
- Buy the USO Feb 17-16 Put Spread for $0.27
- Risk: $27 per 1 Lot
- Reward: $73 per 1 Lot
- Break-even stock price at expiration: $16.73
I like this trade because it gives me plenty of time (45 days to expiration), protecting me from a potential trap or near-term short covering. It also pays nearly 3:1 on my risk capital.
