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$20 Spread Investment Idea – a Bet on Oil:
I continue to investigate investment opportunities in USO, both because there is a large Implied Volatility (IV) advantage to calendar spreads (i.e., longer-term options that you buy are “cheaper” than the shorter-term options that you are selling) and because of the ongoing discussion about which way oil prices are headed (with several investment banks (e.g., Goldman Sachs, Barclays, Citi) telling their clients that oil is headed far lower), and on the other side, other analysts are saying oil is headed higher and hedge funds are covering their shorts. The Iran nuclear deal, if successful and sanctions are lifted, could lower oil prices by $15 according to industry experts, and every rumor concerning how negotiations are going moves USO in one direction or the other.
Right now, the price of oil is about $59 a barrel (and West Texas Crude is about $5 less). The price of USO moves roughly in tandem with this price, changing about $1 for every $2 in the change in the barrel price of oil.
We should know something about the Iran deal by the end of June, but its impact on oil prices is likely to occur later (it seems like sanctions will be gradually reduced over time). The current price of USO has been edging higher in spite of unprecedented supplies, and the possibility of Iran flooding the market even more. My best guess is that USO might be trading around $20 in June compared to its current $18.80.
That is just my guess. You may have an entirely different idea of where the price of oil might be headed. When trading calendar spreads, you want to select a strike price where you believe the stock will be trading when the short options expire. If you are lucky to be near that strike, those options you sold to someone else will expire worthless (or nearly so) and there will be more time premium in the long options you hold that exists for any other option in that time series.
Yesterday, I bought USO Jul-15 – Jun-15 20 calendar spreads (using calls) and paid only $.20 ($20) per spread. If I am lucky enough for USO to be right at $20 when the June options expire, the July calls should be trading about $.80 and I would make about 3 ½ times on my money after commissions. If I missed by a dollar (i.e., USO is at $19 or $21), I should double my money. If I missed by $2 in either direction, I would about break even. More than $2 away from $20, I will probably lose money, but my initial cost was only $20, so how bad can it be?
It seems like a low-cost play that might be fun. I also bought these same spreads at the 19 strike (paying $.21) to hedge my bet a bit. If I triple my money on either of the bets, I will be an overall winner. You may want to bet on lower oil prices in June and buy spreads at a lower strike.
Another way to play this would be to exit early as long as a profit can be assured. If at any time after a month from now, if USO is trading about where it is now, the calendar spread could be sold for about $.30 or more (a Jun-15 – May-20 calendar could be sold for a natural $.32 today). If USO were trading nearer to $20, that spread could be sold for $.37 (which would result in a 40% profit after commissions on the spread that I am suggesting).
With a spread costing as little as this, commissions become important. Terry’s Tips paying subscribers pay $1.25 per option at thinkorswim, even if only one option is bought or sold. A calendar spread (one long option, one short one) results in a $2.50 per spread commission charge. This means that you will incur a total commission of $5 on a spread cost of $20 counting both putting it on and closing it out (unless the short options expire worthless and you don’t have to buy them back – if this happens, your total commission cost would be $3.75 per spread).
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Terry
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