From the March 01, 2011 issue of Futures Magazine • Subscribe!

Rising demand creates floor for crude oil

The United States and most of the northern hemisphere experiences a surge in retail gasoline demand from June through September as "driving season" takes vacationers to the road during the warm summer months. This demand skew shows up at the wholesale level as early as January as distributors begin to stockpile gasoline inventories to meet summer demand. This ramps up demand for production, which in turn ramps up demand for oil.

This one-two effect of refinery maintenance and seasonal demand often can produce late winter/ early spring price rallies in the energy markets. At the very least, it should be one more pillar supporting crude prices over the next several months.

Based on all this, we view the risk of a move in crude prices to be weighted to the upside. However, we do not expect a "blow off" rally either. Recent developments in the middle east have brought additional buying support into the crude market on fears of supply disruptions. We have increased our crude oil price target to the $100-$115 range for Q1-Q2 2011.

Conservative minded bulls can sell $60 (or thereabout) puts and higher premium minded investors could add a $130 short call creating a strangle, which would produce roughly a $1,000 premium (see chart).

Crude oil (continuous)

While these premiums are still available, the oil VIX has been on the decline as of late. We advise entering these trades earlier, rather than waiting as premiums could dry up quickly.

We would not be shy about going out to late summer contracts as these premiums could go quickly if oil settles into a defined range. Remember, as an option seller, all prices have to do is stay above or below your strike price. If it does, you keep the premium. Crude appears to be an optimum market for this strategy at this time.

James Cordier is the founder of Liberty Trading Group/OptionSellers.com. Michael Gross is an analyst with Liberty. They are the authors of "The Complete Guide to Option Selling," 2nd Edition (McGraw-Hill 2009). For more information on selling options, visit their website at www.OptionSellers.com.

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