The “We skipped the Light (sweet crude) Contango” Trade
(5 votes, average: 5 out of 5)
Loading ...Here is a little trade to capture some of the crazy contango in the oil markets.
Ă‚Â
Buy USO ($35ish) and sell Jan2010 ATM calls($8.50ish) (KWWAI.X) against the shares, a simultaneous buy/write. This trade should give an immediate credit of ~25%!
Ă‚Â
A friend of mine asked me to take a look and figure out the best way for him to roll the dice and profit from a rebound in oil. After taking a look at the futures markets I realized that everyone is betting oil will be higher in the future (contango) and they are getting shitty odds to make that bet. So when the house is giving bad odds to the players, you want to be the house. As the house we will be selling the speculative calls to the “gamblers” for 25% of the cost of actually buying the oil. Sweet!(crude) Because we are not making a downside bet in oil; we buy the USO now for ~$35, at the same time we sell the rights to those shares to the speculators for ~$8.50. The $8.50 credit we take now will give us 25% protection to the downside in oil, so as long as oil stays above ~$33 per bbl the trade is profitable. If at expiration, oil is above where it is today ($44 per bbl.) we will get called out of our shares for what we paid and our total profit will be the $8.50 we collected on the calls.
Love this trade, thanks for sharing.
I don’t normally use options, but I have to consider this. thx. What are the risks?
Well the risk is that oil is more than 25% lower than it is right now when these expire in January 2010. Bet even then, you still will have your USO shares because you will not get exercised on.
And you are tying up capital for a whole year to do this, so if some great deal comes along it may be extremely costly to unwind this before expiration.
This particular trade is just an example, you may want to just tie up money until July 09 and you still get 20%. Actually I calculated this over the weekend, but today you are way better off selling the July calls, shit that is 40% annualized return.
Hey Jim, nice post! *****
Good to see you representing Hawaii too! You already highlighted the only thing that stood out to me on this trade… January 2010 expiration. But, it certainly looks good for 6 months too. I can’t wait for people in hawaii to start complaining about gas prices again.
(For those who don’t know, here’s an example of how a covered-call works: http://www.answers.com/topic/covered-call)
Shit Gio, I filled up my Monster Truck for 65 bucks the other day. Stoking on the new low oil prices. This trade is so interesting cuz the option market is pricing in line with the futures market. West Texas Intermediate for Jan 2010 delivery is 38% higher than front month. July delivery is 23% above.
The Jan 09 calls look like they are giving north of 10% for one month, instead of 25% for a year – bit riskier as crude could drop 10% over next month…
Wait until new year then no taxes on the call write until April 2010. Should hold.
To me, there is more “risk” that it goes back to $70 over the next year. That and the fact that it is so tied to geopolitical risk, I wouldn’t want to cap the upside like that. The oil supply valve is closing while the dollar supply valve is opening.