Stability in crude ahead?

It seems that many onlookers feel comfortable that the accentuated weakness in the price of crude oil may have ended. But one option trader appears to be positioning for prices not to budge much over the next couple of years.

One investor sold the January 2017 straddle 2600 times using the United States oil fund, which closely tracks the price of oil futures. The trade expiring in almost two years’ time is possibly aimed at taking advantage of the decay of time value embedded in options prices, while banking on a strictly limited jaywalk in the value of the fund. With the USO trading at $19.00, the investor took in a premium of $6.70 per contract on the trade, which sets breakeven parameters on the straddle strategy of $25.70 to the upside and $12.30 to the downside.

The fund touched its recent low of $16.30 on January 29 when crude oil futures closed at $45.23. Its price last traded above the current breakeven for the strategy on Dec. 3, when crude futures settled at $69.47. The trade commands such a premium in part on account of high implied volatility, which has actually slipped on the day by 7.6% to stand at 42.9%. Volatility peaked on the USO in the days after the price of oil reached its current floor.

By comparison, the same straddle combination using the January 2016 expiration is priced at around $5.00 per contract implying breakeven parameters of $14.00 and $23.00 for the oil fund.

Chart shows USO and crude oil prices

About the Author

Andrew is a seasoned trader and commentator of global financial markets. He worked for several London-based banks trading cash and derivatives before moving to the U.S. to attend graduate school.