This Bet On Oil Using USO Looks Dicey

August 21, 2015

The Pitfalls
It’s easy to think this is the sort of trade you might want to make. After all, you’re only risking $15 per options contract, and this trade could make many times that amount if crude oil continues to collapse.

There are three problems with that thinking. First, you only have seven business days for USO to fall about 16 percent, and that’s pretty unlikely. Second, while these options are “dollar cheap,” since they only cost $0.15, from an options trader’s point of view, they’re pretty expensive, since our trader paid a price that assumes USO will be extremely volatile between now and options expiration.

Finally, a little options math tells us that the odds of a drop below $13.00 are only about 25 percent.

Some traders point to a big options trade, like this one, and ask if it makes sense to join in. They think someone trading that big must be smart or have some sort of insight. Not necessarily.

This trader might already be under water on a long position in USO and is limiting further downside. Or she might have a big profit on a short crude oil position and she’s trying to add to that short position while not adding a lot of risk.

Options on ETFs are a great tool, but as with much in life, you have to do your own homework.

At the time of writing, the author held no position in USO or USO options. Follow Scott on Twitter @ScottNations.

Find your next ETF

Reset All