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Where's Crude Oil Headed?

By Matthew BradbardCommoditiesJul 12, 2013 01:15PM ET's-crude-oil-headed-175206
Where's Crude Oil Headed?
By Matthew Bradbard   |  Jul 12, 2013 01:15PM ET
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In the last three weeks crude oil futures have appreciated 15% lifting prices to 14-month highs. Since lows were established on 4/18, prices have advanced nearly 25%. That will not continue -- at least at this velocity -- and, in fact, at the moment I feel prices have gotten ahead of themselves and we could see deprecation in the short term.

What If?
Instead of saying it will happen tomorrow or even this month, what if we widened the window to allow a trade to play out over the next six, 12 even 18 months? Together with one of my colleagues Kevin Davitt, whom I do a lot of energy trading with, we devised a strategy in the energy sector to do exactly that. Please do not misinterpret me and think that because we have two legs there is less risk…we could be wrong on both legs and incorrect on the directional play…the spread between December 14’ and December 13’ could continue to widen.
Crude Oil: Daily
Crude Oil: Daily

Options Or Futures?
December 14’ Crude is nearing a $9 discount to December 13’ Crude. This is the widest margin we have seen in years. I can only get data back to July 11’ with my software on this spread. Prior to this rout in recent months the highest discount was in the fall of 12’ at $6.50. Every $1 move in the spread equates to a $1,000 gain/loss. In the coming weeks to months I anticipate the spread narrowing to -$4.00-6.00. I think most of the pain is behind us but start with small size and be willing to scale into the trade. In full disclosure I think it a far better way to play this via options vs. outright futures and that is how I will be suggesting my clients to potentially capitalize on this opportunity. See suggested strategy below.
  • Buy December 14’$110 Crude call
  • Sell December 13’ $115 Crude call 1:1:
Crude Oil Strategy
Crude Oil Strategy

  • December 13’ futures @ $100.97
  • December 14’ futures @ $92.00
  • Selling $115 call for approximately $900
  • Buying $110 call for approximately $1,700
  • 127 days until expiration
  • 494 days until expiration 15 delta
  • 19 delta
It looks like this spread can be bought for approximately $800-850. To trade back to the median price we have seen in 13’ lifts this spread back to $1750/1800. What would it take to see this type of price action? The spread narrowing, which would likely mean a noteworthy correction in the near term, dragging crude back to $90/95 barrel. Theta or time decay in the 13’ option that have 75% less time value. An appreciation in forward contracts -- which means we would need to see demand increase on the curve -- which I view as the least likely case for this trade being profitable. Needless to say, for a trade with this risk/reward dynamic I think it merits energy trader’s attention.
Where's Crude Oil Headed?

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Where's Crude Oil Headed?

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