Well I am not going to say that I “called the bottom” in crude oil. Because the reality is that I simply do not possess that ability. That being said, I am pretty good at:
*Spotting trends
*Recognizing wildly “overdone” buying or selling.
(See also It’s Soon or Never for Soybeans)
In this article on 2/16 I highlighted a chart that I saw in this article. The implication of the chart was that crude oil – at least when compared to gold – was, well, wildly overdone to the downside. So on the same day I wrote this article. Today’s piece is an update of the example trade highlighted in that article.
USO Modified Butterfly
I noted at the time that implied option volatility for ticker USO was at an extremely high level and highlighted an example trade using a strategy referred to as a “modified butterfly spread”.
The original trade on 2/16 appears in Figures 1 and 2
Figure 1 – USO July Modified put butterfly (Courtesy www.OptionsAnalysis.com)
Figure 2 – USO July Modified put butterfly risk curves (Courtesy www.OptionsAnalysis.com)
Since that time:
*USO has rise from $8.31 to $10.11 (See Figure 3)
*The implied for USO options has declined – but still may have a lot further to fall (See Figure 4)
Figure 3 – USO bounces (Courtesy AIQ TradingExpert)
Figure 4 – USO implied volatility off of highs (Courtesy www.OptionsAnalysis.com)
So the trade now stands with an open profit of $464 as shown in Figures 5 and 6.
Figure 5 – Updated USO July Modified put butterfly (Courtesy www.OptionsAnalysis.com)
Figure 6 – Updated USO July Modified put butterfly (Courtesy www.OptionsAnalysis.com)
If price were to remain unchanged through July expiration the profit would increase from $464 to $692. However, that is still 130 calendar days away.
Choices:
Sit and wait – if price does not collapse once again and/or implied volatility drifts lower then the trade’s profit will increase over time.
Close the position now – given the volatile nature of crude oil and the fact that this could be nothing more than a rally in a bear market, it might make sense to “take the money and run”.
Adjust – One possibility would be to close half the position. The Good News: If USO dropped back below its low of $7.67 the position could still be exited with a profit (probably in the $200 range). The Bad News: the profit potential drops from $692 to $578 (current open profit = $464), so you would be sitting with a trade for another 130 days for an additional profit potential of $114.
I would be itching to take the money and run at this point. However, an alternative would be to hold on as long as price is stable and IV is declining – but consider closing out the position at the first sign of trouble for USO.
Jay Kaeppel
