Should we be looking to cover our shorts?

Now that oil and gasoline cost less than bottled water maybe it’s time to start looking at covering our short positions. Don’t get me wrong I’m not ready to use the L word just yet ( long ) but I can clearly see long positions on the horizon at lower levels.

The downward spiral is still intact but history has proved short selling parties can’t last forever.

Just how inexpensive is crude oil?

Let’s look at the 30 year chart for a barrel of crude priced in gold

All time high 0.15050 of an ounce June 2008

All time low 0.03322 of an ounce July 1986

Current 0.03370 of an ounce December 2015

1986-2015 average 0.69889

Distance from the all time low priced in gold 0.00048 of an ounce or about 50 cents.

Click on any image to enlarge it

Source & supporting data Federal Reserve data 1986-2105-cost-of-oil-priced-in-gold

1986 – 2015 oil gold ratio, (oil normally trades above gold on this ratio)

Source Federal Reserve

Historically

Is $34.52 per barrel misleading if you look at the historical price action from 1993-2015 calculated in inflation adjusted dollars?

All time high $147.27 per barrel July 2008 ($162.34 in 2015 USD)

All time low $10.35 per barrel December 1998 ($15.80 in 2015 USD)

The 30 year average price for oil is $42.87 ($59.09 in 2015 USD)

2015 dollars generated using the BLS.GOV Inflation Calculator

Current cash oil price $34.52 per barrel

Data source Chicago Mercantile Exchange

The Fundamentals are still weak

The technical’s are still weak

Daily = downtrend

Weekly = downtrend

Monthly = downtrend

The spread between a gallon WTI crude and wholesale gasoline is more than twice the historical average.

1990-2015 historical average, $0.2147 ($0.28 in 2015 dollars)

Current 12 month rolling average = $0.4426

Spread between WTI crude and retail gasoline, better than average

1990-2015 historical average is $0.8642 ($1.14 in 2015 USD)

Current 12 month rolling average = $1.2612

Spread between wholesale and retail gasoline, consistent with the historical average.

1990-2015 historical average is $0.6496 ($0.86 in 2015 USD)

Current 12 month rolling average = $0.8186

Where the Futures market is pricing Crude Oil through December 2024

Ratios tell me to maintain shorts, technicals say stay short, futures markets indicate higher prices.

One current crude oil position to track

Short March 2016 deliver at $46.80, contract value $46,800

Deposit posted per contract = $15,000

Exchange margin per contract = $3,800

March 2016 is currently trading at $36.74, contract value $36,740

I’d like to cover these $46.80 shorts, reverse to long at $33.00.

1) to cover my $46.80 shorts I’m going to write a put at the $33.00 strike collecting $1.24 per barrel or $1,240 per contract (expires in 58 days). The only way my current $46.80 short can be “pulled” away is if the market falls from the current price of $36.74 down to $33.00. Should this occur my short position would appreciate by another $3,740 per contract between now and 17 February 2016 expiration. If March delivery never goes down to $33.00 I keep the $1,240 put premium collected against my $46.80 short.

2) I’m also going the write another put at $33.00 collecting another $1,240, again if March 2016 WTI crude does not trade down to $33.00 I keep the $1,240 in time premium. If it does go below $33.00 I was paid $1,240 to enter a new long position at $33.00 or $3,740 per contract better than where the market is currently trading ($36.74), (yes I’ll have to offset and roll the position in March)

3) If the market stays the same I’ve collected $2,480 over the next 58 days on a position if delivered is worth $33,000.

4) If oil starts to rally I can cover my $46.80 shorts and watch the $33.00 puts expire worthless (+$2,480). There are several other ways to offset my $46.80 shorts, example, writing an in the money put at $40.00 currently trading at $4.59 collecting $4,590 in premium ($920 in time value)

On the upside the current position is trading at $36.74 contract value $36,740 (1000 barrel contract X $36.74 per barrel) or I’m getting paid 6.750% in total time value over the next 58 days to liquidate my $46.80 if the market goes down to $33.00

If $33.00 is put is hit my gain on the trade = $13,800 per contract plus the collected time value of $2,480 for a total of $16,200.

The margin I’m allocating on this position is $15,000 per contract. (Exchange margin = $3,800 per contract)

What this strategy has done is paid me 16.53% in option time value on my $15,000 deposit per contract to be patient over the next 58 days.

Many traders don’t realize how collecting fat time premium can work for you.

Let’s assume the market is right and crude oil bottoms at the current price of $36.74 (March 2016 delivery)

Let’s assume you go long crude oil at $36.74

Wrote an out of the money call at $39.50

$39.50 call is trading at $1.59

You’re collecting $1.59 per barrel, $1,590 per contract, $27.41 per day or $10,006 per year on a position that has a total value of $36,740.

The time value writing out of the money options = 27.23% in annual time premium collected or 66.70% on the $15,000 allocated to cover the $3,800 in exchange margin.

We’re posting $11,200 more than is required by the exchange to minimize the probability of a call. Our margin for error without being in jeopardy of having a call is $11.20 a barrel plus whatever option premium collected, in this case $1.59 for a total of $12.79.

In order for us to be on call (in this example) March 2016 crude oil would need to fall below $23.95 a barrel between now and 17 February 2016 (58 days). Again I’m not advocating getting in at $36.74, I’m using this as an example to show you how hefty the time premium is writing out of the money calls to generate income against a long crude oil position.

In this example the only way your $36.80 position can be called away from us is at $39.50 for a $2.70 profit per barrel or $2,700 per contract. If it does not get called away we’d keep the time premium against our long of $1,590 (+10.60% on the $15,000 deposit for 58 days).

In my case I’m writing the $33.00 put to get into a $33.00 long position collecting $1,240 in time value, if delivered at $33.00 I’ll write the $36.00 or $37.00 call against the delivered $33.00 long collecting anther $1,000 to $2,500 against the $33.00 long. (I will have to roll this position to forward delivery month)

Energy Stocks

Energy stocks might not be a sick as all the academic chatter generated by the tradeless master debaters. Sure crude may go down to $20 maybe $10 who cares? There are defined risk strategies to capture the move in both crude and energy stocks if you’re up to speed and can handle the risk.

Fact over the next 5 years the world will need energy and the additional products crude produces. Demand may go down but population will increase and there are scores of situations that could generate a nice rally in crude from the low 30’s as well as energy stocks.

Many of these energy stocks you can trade using same strategy of writing puts to get in and calls to get out as I’ve explained in the crude oil example above. Word of caution you have to watch your bid/ask spreads, make sure you get firm quotes on the bid/ask, match them up to your other desks and always use price orders.

On the horizon I see short covering and potential net new long positions entering in energy stocks. Yes, the charts still look ugly, if you want to be less aggressive wait for the turn (change in trend) using something as simple as a Bollinger 20,2 and exponential moving average 9 on weekly data in the examples below.

Exxon Mobil Corporation (XOM)

BP P.L.C. (BP)

Royal Dutch Shell plc (RDS.A)

Chevron Corporation (CVX)

Valero Energy Corporation (VLO) (no short on this)

Petrobras – Petroleo Brasileiro S.A. (PBR)

Marathon Petroleum Corp. (MPC) (no short this)

ConocoPhillips (COP)

Suncor Energy Inc. (SU)

TOTAL S.A. (TOT)

Statoil ASA (STO)

Yes, oil is inexpensive and appears to be moving lower but the world still needs it. We will eventually find a bottom, might as well get paid on our short positions while we wait.

If you have questions or would like additional information contact me. 

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RISK DISCLOSURE STATEMENT PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

UNTIL REGULATORY REFORM IS ESTABLISHED IN THE U.S.  WE ARE NOT ACCEPTING U.S. ACCOUNTS.

EXAMPLES OF HISTORIC PRICE MOVES OR EXTREME MARKET CONDITIONS ARE NOT MEANT TO IMPLY THAT SUCH MOVES OR CONDITIONS ARE COMMON OCCURRENCES OR ARE LIKELY TO OCCUR. HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS.

THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADE PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.

BID/ASK SPREADS, BROKERAGE COMMISSION, CLEARING, EXCHANGE AND REGULATORY FEES WILL HAVE AN ADVERSE IMPACT ON THE NET OVERALL PERFORMANCE OF YOUR ACCOUNT. PRIOR TO MAKING A DECISION TO PARTICIPATE IN ANY INVESTMENT MAKE SURE YOU FULLY UNDERSTAND THE FEES ASSOCIATED WITH TRADING.

THE INFORMATION PROVIDED IN THIS REPORT CONTAINS RESEARCH, MARKET COMMENTARY AND TRADE RECOMMENDATIONS. YOU MAY BE SOLICITED FOR AN ACCOUNT BY ONE OF OUR REPRESENTATIVES OR EMPLOYEES. IT SHOULD BE KNOWN THAT THE REPRESENTATIVES OF ANY FIRM MAY TRADE FUTURES AND OPTIONS FOR THEIR OWN ACCOUNTS OR THOSE OF OTHERS. DUE TO VARIOUS FACTORS (SUCH AS MARGIN REQUIREMENTS, RISK FACTORS, TRADING OBJECTIVES, TRADING INSTRUCTIONS, TRADING STRATEGIES, AND OTHER FACTORS) SUCH TRADING MAY RESULT IN THE LIQUIDATION OR INITIATION OF FUTURES OR OPTIONS POSITIONS MAY DIFFER FROM THE OPINIONS AND RECOMMENDATIONS FOUND IN THIS REPORT.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. THE RISK OF LOSS IN DERIVATIVE CONTRACTS CAN BE SUBSTANTIAL THEREFORE INVESTORS SHOULD UNDERSTAND THE RISKS INVOLVED IN TAKING ANY LEVERAGED POSITION AND MUST BE IN A POSITION ASSUME LOSS FOR THE RISKS ASSOCIATED WITH SUCH INVESTMENTS AND FOR TRADE RESULTS.

PLEASE CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES AND RESOURCES.

 

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Asset Investment Management

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