New Crude reco:

Posted on 07/21/2011


The prospects of a new Euro bailout, which on first glance reeks of a unique brand of off balance sheet monetization, has put pressure on the US $ and in a lockstep, Euro driven market, most all risk assets are moving higher.

The S&Ps are pushing 1340 (Sept futures), which has provided some resistance in the past few months. Combine that with stretched technicals and a VIX that’s moved from ~22 to ~17 in short order and the question becomes, where/how best to position for a potential retrace?

My answer – Crude!

Crude (WTI) is bumping up against the $100 level, which like it or not, plays some psychological role (for the few actual human traders in the algo/high frequency world). Euro/world crude (Brent) is again testing $120.

I’ve always been a fan of ratio spreading in situations where you feel a market may be extended, but want to limit dollar risk in the event it continues to move in the same direction.

Moderate risk appetite: Work to BUY ONE Sept Crude (WTI) 95 put v. SELLING TWO Sept Crude 90 puts @ .25. 27 days until expiration (8/17/2001). $250 (plus frictional costs) in UPSIDE dollar risk. Things on the downside get a bit more slippery and if you think Crude could break $85.25 in the next month – this trade is not for you. Best case scenario is Crude parking at 90 at expiration, which is highly unlikely. In that case, the position is worth $5k, you paid $250…, a sweet payoff. At expiration, the position makes money between $95 and $85.25, BELOW $85.25 @ expiration, YOU WILL LOSE MONEY.

Elevated risk appetite: Do the same trade listed above AND SELL the Sept 106 Calls (recent highs) to finance the position. You should be able to swing the whole trade for a $600 CREDIT (in other words, buy the ratio spread for .25 and sell the upside call for .85 – net credit of .60).

The more aggressive position will make a bit of money (best case $600 less commission) in the event crude stays between $85 and $106 at expiration (which I consider highly probable). It does very well @ $90 ($5,600), loses money starting at $84.40 and $106.60. Losses outside of those levels are unlimited.