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

October 15, 2012


WTI crude oil is hanging around the $90 level right now. At the moment, the January $120 calls expire Dec. 15 and are going for approximately $210 (plus commissions and fees). If there were a $100 move in crude prices, these options would be $70 in-the-money. Each WTI crude contract is for 1,000 barrels, so if this option were $70 in-the-money, its value would equate to $70,000.

I’d suggest you buy options that have at least a three-month time premium. In 1990, it took about three months for crude oil to double in value. If a crude production quelling event occurred today, it could take three months for crude oil to reach its peak price. There certainly is no guarantee that if an event did occur today, the price movement would occur in a similar fashion or at all; I’m simply using it to frame this particular options strategy.

In my opinion, if you’ve purchased the options and the spike in prices has not happened and you have less than three months until expiration, I’d recommend rolling over your position for more time (additional commissions and fees would normally apply).

If this major price surge were to happen for crude oil, it may not take months, with the rally perhaps only lasting hours long. Seeing how this could be a huge move that could happen overnight when option liquidity is low, in that scenario, I’d recommend selling futures against what would be in-the-money options. This is because your options may not fill overnight, but futures most likely would.

For example, if you’re long a $120 crude option, you can sell the December future on a GTC order at $170/barrel (plus commissions & fees). A GTC order is an order that is “good ’til canceled,” meaning it keeps working until the order is filled at a specific price or is canceled. The difference between the $120 call and the $170/barrel futures would be $50,000 (minus commissions and fees). Again, if your options have less than three months until expiration and you still feel there is a possibility of events happening, I suggest you buy more time, or roll over (additional commissions and fees normally would apply).

Although the trend is down on the daily chart for crude oil and it appears range-bound on the weekly and monthly charts, in my opinion, we could have a substantial rally.

Even if things quiet down in the Middle East and fears of curbed crude production subside, crude could have a pretty substantial rally anyway, as the macroeconomic picture seems to be improving.


WTI Crude Oil 1990 Weekly Chart



Disclaimer: Futures, options and forex trading is speculative in nature and involves substantial risk of loss. These recommendations are a solicitation for entering into derivatives transactions. All known news and events have already been factored into the price of the underlying derivatives discussed. From time to time, persons affiliated with Zaner, or its associated companies, may have positions in recommended and other derivatives.

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