Crude oil has gotten a lot of headlines over the past few weeks, sparking big moves in the oil market. WTI crude oil prices surged over 45% higher this year, before dipping 5% over the last month.
Fortunately, there is a way to directly profit from the dip in oil prices, and we don’t mean storing a few dozen barrels of black gold in your garage. And you don’t even have to speculate in the futures markets to take advantage of the current trend.
By using the power of options, we can shoot for triple-digit gains while limiting the capital we place at risk. We’ll describe how to do that a little later.
But first, we have to explain why the oil market rally is poised to continue.
Oil bottomed in December of last year, right alongside the stock market. Both rallied steadily this year on news that the economy was stronger, among other factors. After months of gains, the oil market was susceptible to some sort of reaction, either a panicky gain or a needed pullback.
The market gave us both!
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Last week, crude jumped up to a fresh six-month high on news that the United States would impose sanctions on all buyers of Iranian oil. Then, only four trading days later, the market jumped back down to the tune of 3% after the president tweeted that the Saudis and OPEC should pump more oil to make up for the missing Iranian supplies.
The Saudis quickly denied this request. In fact, Bloomberg reported that the Saudis need oil closer to $85 a barrel – up from its current $63.91 – to balance its budget.
But that’s not the only catalyst that will drive oil prices through the rest of the year…
What’s Pushing the Price of Oil Higher
Money Morning Global Energy Strategist Dr. Kent Moors believes three main factors are coming together to keep the gains coming, even if only at a modest pace.
First, while weekly production totals will fluctuate and affect prices, it will not translate into a firm price ceiling. The balance struck by operating companies even in an overall rising production environment allows for a rise to continue, even if slowly.
A second factor is that oil prices will continue to be determined by demand someplace other than North America or Western Europe. Essentially, this means demand (and prices) will increasingly be driven by what occurs in Asia, where the energy sector as a whole will progressively take its bearings until at least 2035-2040.
And this does not even take into account geopolitical turmoil, like the unrest in Venezuela, which once was an oil exporting powerhouse. After years of decline, it no longer contributes much to global supplies, but even so, the current potential coup taking place there, coupled with uncertainty over OPEC output cuts, increases risks to global oil supplies.
Dr. Moors’ conservative oil price prediction for 2019 is $72 a barrel, a 14% gain over today’s prices. That’s a nice gain if you invest in oil futures contracts, but we can pour gas on it with this options play.
And it could make you 123% gains.
This chart shows you exactly how…
Here’s How to Use Options on Oil Prices
Now for the trade we promised earlier.
We’ll do this using the United States Oil Fund (NYSEArca: USO), which holds the near-month NYMEX crude oil futures contract and rolls it over to the next month contract before expiration. The most important point here is that the fund trades like a stock on the New York Stock Exchange.
Using options on the USO oil fund, we can take advantage of relatively low premiums with long-dated, out-of-the-money calls. Let’s break that down first.
Call options give the holder the right, but not the obligation, to buy a fixed amount of something at a fixed price by a fixed time in the future.
For this trade, we will look at options expiring in December with a $14.50 strike price.
With the current price of USO at $13.29 as of Tuesday’s close, the $14.50 strike price is above the price of the underlying oil fund, or out of the money. We do this because if the forecast for higher prices is current, these options will be in the money before they expire, meaning they will lock in gains.
The next question is, “Why December?”
Right now, over 80% of global oil consumption occurs in the Northern Hemisphere, led by the United States, according to financial service firm PGM Capital. This means that oil prices tend to rise during the summer driving season, thanks to gasoline demand. And they stay elevated during hurricane season, finally peaking in October, on average.
Therefore, by holding options expiring in December, we can cash out in October while there is still time left in the options. Remember, the time value of options decays every day, but more quickly as expiration approaches.
The USO December 2019 call with the $14.50 strike price closed trading Tuesday at an ask price of $0.67, or $67 per contract. If USO makes it back to last year’s high just above $16, at the December expiration, the option will be worth $16. That means you’ll bank a profit of $150 per contract. That’s a 123.9% gain.
But remember, we are not going to hold it past October. If USO makes it to $16 by then, it will have both the intrinsic value of $150 per contract but the remaining time value, as well, to boost the gain even higher.
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