Playing Volatile Oil Prices (Guest Columnist at Barron’s)
Today I penned my
eighteenth guest column for Barron’s,
filling in for Steve
Sears and the venerable The
Striking Price options column. Looking
back, I was surprised to see that this is the eighth year I have been
contributing to Barron’s and while I have generally tilted in the direction of
volatility topics during this period, I always like to keep my thoughts
topical, but with an unusual twist or two.
In Playing
Volatile Oil Prices: The ins and outs of
the backspread trade, I tackled the recent huge moves in crude oil
prices, touched upon some of the fundamental and technical influences on the
price of crude and used the current environment of chaos following a huge short
squeeze as a backdrop to talk about the opportunities associated with a call
backspread.
As Barron’s
prefers to structure trade ideas around ETPs or single stocks, I elected to use
the popular U.S. Oil Fund (USO) ETP as my
underlying, though I also like the idea of call backspreads in oil and gas
exploration and production (XOP) or Russia (RSX), though the
Russia ETP has limited liquidity. As an
aside, readers of this blog will surely know that the prices of futures-based
ETPs such as USO and VXX,
among others, are strongly influenced by the roll yield
associated with the shape of the futures curve.
For this reason, USO acts most like West Texas Intermediate crude oil in
the short-term, but over longer periods the price of USO is more strongly
affected by the term
structure of crude oil futures, similar to the issues
associated with VXX and the VIX.
While the Barron’s
column discusses the rationale for the trade and some of the details
surrounding it, I thought I would post a profit and loss graphic for the USO
April 1x2 10.5/11.5 call backspread here as a companion to the Barron’s
material.
[source(s):
LivevolPro / CBOE, VIX and More]
I am sure this
particular call backspread trade idea is not for everyone, yet I think it is
important for everyone to internalize backspreads, their P&L chart and some
of the tweaks that can be made. For
instance, one can dramatically change probabilities and payoffs by modifying
strikes (including making use of in-the-money strikes, for instance) and
expirations, whereas the credit or debit for entering the trade is something
that can be strongly influenced by adjusting the ratios to the likes of 2x3, 4x5,
etc.
Also of note,
readers who are new to backspreads may wish to brush up on bear
call spreads (and bull put
spreads) before tackling backspreads, as I like to think of backspreads as
short vertical spreads that are supplemented by the purchase an extra
out-of-the-money option in the time-honored tradition of swinging for the
fences with some of the profits from a spread trade.
As I concluded
in the column, “In the options world, there are very few trades where you can
make money should the underlying shares move sharply in either direction.
Backspreads are intriguing in that they have limited risk, unlimited reward (in
one direction), and can make money if the underlying moves either up or down.”
- Turmoil in the Oil Patch
- Chart of the Week: Crude Oil and Volatility
- Crude Oil Volatility Slides with Crude Prices
- Chart of the Week: Flight to Safety ETPs
- Chart of the Week: Crude Oil and Transports
- Clean vs. Not-So-Clean Energy
- Crossroads Options
- BP, Put Backspreads and the Disaster Trade
- Selling Fear with a DryShips Bear Call Spread
- Playing Volatile Oil Prices (March 12, 2016)
- The Case Against High Stock-Market Volatility in 2016 (January 2, 2016)
- Seizing Opportunity from Stock Market Volatility (July 11, 2015)
- How to Ride an Aging Bull (November 29, 2014)
- Investors' Best Options in a ‘No Fear’ Market (July 2, 2014)
- Low Volatility: How to Profit from a Quiet VIX (May 22, 2014)
- Emerging Market Stocks: Have They Hit Bottom? (March 28, 2014)
- How to Spot Risk Early (July 16, 2013)
- How to Insure Your Stock Portfolio (April 18, 2013)
- The Case for Options Trading (January 2, 2013)
- Calm Down and Exploit Others’ Anxieties (November 14, 2012)
- How to Trade Options Around Volatile Events (July 10, 2012)
- Be Greedy While Others Are Fearful (May 3, 2012)
- Ways to Turn Volatility into an Asset Class (January 12, 2011)
- There’s Opportunity in Uncertainty (November 18, 2010)
- Will Market Volatility Return to Crisis Levels? (September 15, 2010)
- The Perils of Predicting Volatility (May 20, 2010)
- Take a Longer View on Volatility (July 2, 2009)
Disclosure(s): long XOP and short VXX at time of writing; Livevol
and CBOE are advertisers on VIX and More
