Tom's Weekly Outlook, July 4th, 2008
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July 4, 2008
Happy Oil Dependence Day!!!
Figure 1 USO Price Chart
I’m not the only one who''s noticed that the price of oil has doubled in the past year. That’s right folks, this time last year oil was priced just above 70 dollars a barrel. I never would have guessed that the price of oil would have risen to double its price in just one year, but it sure has. In fact, it’s risen more than 50 dollars a barrel in the past six months; it just seems like there’s no end in sight.
The chart above shows the Oil Trust (USO), which trades percentages of petroleum products, but has a great correlation to the Light Crude Oil. The chart is an amazing testament to the magnitude of the elevation in prices. One can only imagine the global effect.
So how does this affect the Fourth of July weekend? Well, the fireworks and explosions can be heard all around the world... Food prices on average are up around 10% versus last year. One of the biggest increases is in the price of corn—up more than 40% this year. While many people battle the rise in food prices, others have been made homeless by floods ravaging the heartlands and by fires burning up the hills and homes of California. But those aren’t the real reasons the food at your local store is on the rise. There is one main reason why the price of food keeps going up: energy prices. Bottom line, it takes gas to get the food from point A to point B, and the rise in gas prices is reflected in the cost of food. If the rise in the cost of gasoline won’t wake Americans up, perhaps the cost of what they put in their mouths will. If this trend continues, consumer confidence will continue to fall, along with real estate prices, and stock prices. Not the happy scenario, but very real.
As a contrarian, I have to think that this is going to break soon. Yes, I do believe that oil will be headed higher, but when the entire investing community is bullish on oil, then there is no place to go other than down for the short term. So what can we do to have a great month of July at reasonable risks? OPTIONS!!!
JUST RELEASED… Options on USO!!! That’s right, we can now invest in options on USO. Until recently there was no options listed on this trust, but now not only are there options, but LEAPS options as well. So let’s toy with an example of the right way to play the oil market in the event of a pullback:
Figure 2 USO Bear Put Spread
The table above shows a Bear Put Spread. The risk is spread off by selling a farther out strike than the one purchased. Hence, the risk here is much less than the potential reward. Note how that looks in the risk graph shown below.
Figure 3 USO Bear Put Spread Risk Graph
The Optionetics Platinum site is full of strikes and expiration dates, so try and create your own debit spread. Happy Oil Dependence Day!!!
Tom Gentile
Host of Trader Talk Radio
www.tradertalkradio.com
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