In today’s Options Action episode, Mike discussed a “neutral trade” in USO, the ETF that seeks to track crude oil’s price performance.
Mike noted that crude oil prices had risen nicely since the price finished basing in November of 2020. Indeed, Carter Braxton Worth, the Chart Master, indicated that after a wicked run higher, the price of West Taxes Intermediate Crude peaked a few days ago and has taken it on the chin since the top. This price action may indicate that a pause, at least, is in the cards.
But it is challenging for individual investors to buy and hold crude oil. Not too many of us have an oil take sitting in our back yard. Retail investors have to look to the ETF market, and USO is the financial instrument of choice. This ETF buys and hold short-dated Futures Contracts on WTI Crude. He noted a carry, storage, and insurance element to the Futures, which often causes the Futures to underperform the spot price of crude.
Mike notes that the price of USO has not rebounded anywhere near as sharply as the cost of carrying the Future Contracts dampened the bounce since the November low. This muted price action creates an intriguing set-up. If you are a USO owner looking for higher prices, you might be a little disappointed due to the slippage. So an investor might want to consider selling a monthly March $37 strike call against their stock. One could collect a $1.20 premium or so for doing so.
We want to be sure our followers and the viewers on CNBC’s Options Action are clear on what MIke discussed. The above chart, which aired on the show, presents the performance of a naked short call. That is, it is a short call position that is not matched up against the underlying ETF. MIke would like to be precise. He suggested investors sell a call against their USO ETF holding. We describe that intended structure below.
Since the stock is trading at $35.45, the structure can still deliver an additional capital gain of $1.66 or 4.7%. Add this gain to the $1.20 premium collected by sellling a call option, and one could earn as much as $2.86 (1.20+1.66) or 8.4% on their money in 63 days.
Buy writes are the most commonly used strategy employed by investors and options traders alike. They have slightly less downside risk as compared to a long only stock holding. They provided a much better return if the share price stagnates or moves modestly. However, the outperformance in a flat scenario comes with a cost of giving up large upside gains should the RETF take off. But since USO has already had a big run, this seems like a risk worth taking.
We like to remind our readers that investing involves risk and that it is possible for one to lose most or all their investment when trading options (or any investment for that matter). Be sure to trade within the limits of your capital. Limit the size of your trades to an amount that will not harm you should they result in a loss.
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The following is a full replay of the discussion presented to the CNBC audience.
Gave a great weekend.
Photo by Bud Helisson on Unsplash
