Larry Baer’s Technicals: ‘Powder Keg’ Option Strategy Designed To Take Advantage Of Possible $100 Jump In Crude Oil

October 15, 2012

The potential for a large move in crude oil prices in the aftermath of a Middle East military conflict has historic precedent.


It seems like every day a new headline is splashed atop newspapers and across computer screens about war between Iran and Israel and unrest igniting all over the Middle East. The chain of events and unintended consequences is as unpredictable as it is frightening.

Based on these headlines, another real possibility is that the price of crude oil on the heels of any armed conflict in the area may cause prices to rise.

In the world of finance, planning for the worst-case scenario is one of the foundations of hedging—and opportunity. For example, although it’s unlikely to reach its potential or even be profitable, here is a relatively inexpensive crude oil options strategy you may want to take advantage of that is designed to buy a $200 option that could turn into being worth $50,000 (minus commissions and fees).

Note: Trading options on futures involves significant risk of loss and is not suitable for all people.

Iranian riot police sealed off parts of downtown Tehran last Wednesday [10/03/12] and fired tear gas following street protests triggered by the country’s tumbling currency. At almost the same time, Syria began again to fire artillery into neighboring Turkey, who has now authorized military action if this reoccurs. Throw into this mix a civil war in Libya, rising tensions between Arab nations and Israel, and an Egypt where the political infrastructure has yet to be rebuilt, and the idea that the Middle East may be on a dangerous precipice does not seem far-fetched.

If war were to erupt today, there is no guarantee that this would impact crude prices in the same way, the same time frame, etc., but historically, unrest and war in the Middle East can cause huge price swings in crude oil. The Iranian Revolution of 1979 reduced the production of oil by approximately 2 to 2.5 million barrels per day, resulting in a 10  percent reduction in worldwide crude oil production, which more than doubled oil prices from $14 to $35 per barrel.

Fast-forward to late July 1990, when Iraqi troops were massing along the Kuwait borders. Iraq invaded overnight when the oil markets were closed, and when we awoke the next morning, crude prices had already begun an intense rally. Crude oil ended up doubling in price. (Past performance is no guarantee of future results.)

President George H.W. Bush gave Saddam Hussein an ultimatum that he must exit Kuwait by a certain date, or else face the consequences. Iraqi forces did not retreat from Kuwaiti soil by the prescribed date, but U.S. forces waited an additional two weeks to invade. Why? One of reasons was that it allowed the U.S. military to arrive under the darkness of the new moon.

The new moon occurs in the Middle East on Nov. 14, Dec. 13, Jan. 11 and Feb. 10. If military actions do occur, they may wait until the cover of the moonless night sky to commence engagement.

Right now, the U.S. military has three aircraft carrier groups in the Persian Gulf, which is unusual, and the most ever during nonwartime (Source: The closing of the Strait of Hormuz, war or civil war, a terrorist act or almost anything could disrupt oil production in a significant way, which may cause a knee-jerk rally for crude.


Find your next ETF

Reset All