The recent plunge in crude oil prices has come as a welcome relief to U.S. and world consumers, who were starting to get accustomed to $75 per barrel oil. In a market that was fundamentally overpriced, it seemed only a matter of time until the market shrugged off political events that could pose some type of supply threat, and began focusing on current supplies.
This meant the market finally had to account for U.S. crude supplies at seven-year highs, and it is a testament to world oil producers built this U.S. crude stockpile in the face of record worldwide demand. OPEC was happy to pump as much oil as possible at $75 per barrel. Now with prices hovering near $60 per barrel, OPEC has decided that a production cut may be in order.
This week brought news that OPEC had reached a consensus on a production cut of 1-million barrels per day. This would represent a 3.4% cut to total OPEC production, which currently averages about 29.47-million barrels per day.
A consensus, however, is not a formal agreement. The United States has made it plainly clear that it opposes any type of production cuts. Falling gasoline prices are one of the few things the current administration has going for it heading into fall elections. While Venezuela and Iran could probably care less if the United States opposes cuts, the Saudi’s would generally prefer to keep things on an even keel with their American trade partners. Saudi Arabia is by far the world’s largest producer and exporter of oil and carries the biggest weight within OPEC. The Saudi’s good relationship with the current administration is well documented, and their willingness to help should not be underestimated. For this reason that we expect any type of production cuts to take time, as the Saudi’s drag their feet on a formal agreement until after the U.S. mid-term elections.
However, pressure from other OPEC nations will mean the Saudi’s will not be able to stall forever. We expect more dialog in the coming weeks building up to some type of production cut in November.
In the meantime, oil prices appear to be probing for a low. While energy prices tend to make seasonal lows in December, this year has not been a typical year for crude oil products. Energies are still following seasonal norms to some degree but appear to be about a month ahead of seasonal price tendencies. If this continues, we would expect to establish a major low in crude oil over the next four to six weeks; roughly coinciding with some type of OPEC production cut and heading into the high demand U.S. winter.
While we don’t see prices moving decidedly higher within the next 30 days, we think the implied volatility in the December puts will present some solid opportunities for selling these options for premium in the coming one to three weeks.
For traders not familiar with option selling, selling a put allows a trader to profit regardless of the market moving higher. For instance, if a trader sells a crude oil 53 put for $500, as long as the crude market is above $53 at option expiration, the option expires worthless and the seller of that option keeps the $500 as profit. Selling the put in some circumstances can contain the same amount of risk as buying a futures contract and one should be comfortable with such risks before selling the options. However, there are many effective ways of managing and/or limiting this risk, which can allow even a timid investor to utilize this high-percentage strategy.
Crude oil appears to be reaching a value level at current prices while the fundamental outlook is gradually taking on a decidedly more bullish tone. We would be inclined to begin selling the occasional high priced put option in crude over the coming weeks with an eye towards establishing a major position after the fall elections.
Be sure to catch Bloomberg Radio’s live interview with James Cordier on the energy markets, Monday, Oct. 9 at 3:06 pm (EST).
If you would like to learn more about option selling in crude oil or building a portfolio based on the option selling approach, feel free to contact us:
Liberty Trading Group
James Cordier is head trader and president of Liberty Trading Group, a futures brokerage firm specializing in option writing on commodities. James’ market comments are published by several international financial publications and worldwide news services including The Wall Street Journal, Reuters World News and Bloomberg Television News. Michael Gross is an analyst with Liberty Trading Group. Mr. Cordier’s and Mr. Gross’ book, The Complete Guide to Option Selling (McGraw-Hill 2005) is available at bookstores and online retailers now.
***The information in this article has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account size. Before trading, one should be aware that with the potential for profits, there is also potential for losses, which may be very large. All opinions expressed are current opinions and are subject to change without notice.