When you boil it all the way down, it can be argued that trading is really a fairly simple two-step process.
Step 1. Spot Opportunity
Step 2. Exploit Opportunity
I learned this fairly simple mantra while I worked with Optionetics back in the 2000’s. Two of the co-founders – the late George Fontanills and Tom Gentile would engage in a back-and-forth where one would highlight an “opportunity” that they’d “spotted” and then they would take turn detailing some strategy to “exploit” the opportunity.
OK, in practice things can be a bit more complicated. But if you approach trading with that mindsight it can simplify the process immensely – i.e., everything you do involves either, a) finding a decent setup, or, b) figuring out how to take advantage of that setup.
Like I said, simple. Right?
Crude Oil
For the record, if there is one thing that I have never really demonstrated any ability to do, it is to predict the next move in the price of crude oil. So, for the record, what follows is NOT a “recommendation”, but merely an “example” of spotting potential opportunity and trying to find a relatively low risk way to exploit it.
Figure 1 displays spot crude oil – weekly bar chart on the top and daily bar chart on the bottom. The key thing to note is that the Elliott Wave count (as generated using the objective algorithm built into ProfitSource by HUBB) for both time frames is presently bullish, i.e., pointing to an “up” Wave 5.
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Figure 1 – Weekly and Daily Elliott Wave counts “bullish” for crude oil (Courtesy ProfitSource by HUBB)
The Good News is that my experience has been that when both weekly and daily line up as Wave 5 bullish or bearish there is often a good tradable move. The Bad News is, “not always”. In other words, this configuration highlights a potential bullish “opportunity”, however, there is no guarantee and betting on such an outcome should be viewed as a very speculative endeavor.
Figure 2 displays the daily bar chart for ticker USO – an ETF designed to track the price of crude oil. It too shows a bullish Elliott Wave configuration.
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Figure 2 – Ticker USO
Another key to spotting opportunity is to put as many factors in your favor as possible (all the while remembering that the trade can go south quickly and dramatically regardless). Figure 3 displays the annual seasonal trend for crude oil from www.sentimentrader.com. As you can see the next few months form sort of the “last gasp” bullish period for crude before the typical early winter weakness.
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Figure 3 – Crude Oil Annual Seasonal Trend (Courtesy Sentimentrader.com)
Finally Figure 4 (from www.OptionsAnalysis.com) shows that the implied volatility (the black line on the bar chart) for options on USO is relatively low, i.e., options are “cheap” as there is no a lot of time premium built into the price of the options.
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Figure 4 – Ticker USO; implied volatility (IV) is relatively low; i.e., options are “cheap” (Courtesy www.OptionsAnalysis.com)
So, let’s assume a trader finds this a compelling bullish opportunity (and again, I am not claiming that it is). How to exploit said opportunity? There are many ways, with buying shares of USO being the most straightforward. Another simple approach would be to buy a call option on USO. With IV low this makes sense. The example I will use involves:
*Buying USO Jan2019 14 call @ $1.04
Buying one call costs $104 and gives you a “delta” of 56.85. This simply means that this position will act much like a position of buying 57 shares of USO (however, it would cost you $803 – $14.08 a shares x 57 shares) to enter that position. So, in this example our total cost – and total maximum risk is $104.
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Figure 5 – USO January call (Courtesy www.OptionsAnalysis.com)
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Figure 6 – USO January call risk curves (Courtesy www.OptionsAnalysis.com)
As you can see in Figure 6 the outcomes are pretty straightforward:
*If USO goes up a lot this trade can make good money
*If USO remains unchanged or declines this trade will lose money, period
Summary
So as far as evaluating this “example” opportunity it comes down to this:
1. Do you put any faith in the bullish Elliott Wave counts for crude oil and USO?
2. Do you put any faith in crude exhibiting seasonal strength in the weeks ahead?
3. Do you have $104 bucks?
Jay Kaeppel
Disclaimer: The data presented herein were obtained from various third-party sources. While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.
