Crude Oil At $100/barrel Is Opportunity For Call Sellers

The last time oil traded at $100 per barrel, we advised shorting the market by selling call options. This week, oil once again traded (and closed) above this psychologically important level. Our advice? Sell more calls.

As we explained on Bloomberg television this week (See full video interview on the In The News page of www.OptionSellers.com ), crude oil is experiencing a psychological disconnect from their true fundamentals. Does this mean the fundamentals for crude oil are bearish? Longer term, no, they are not. But bull markets, especially those with the media attention of crude, have a tendency to get overextended at times. This is the reason that markets rarely move in a straight line, but rather a series of fits and starts.

This latest drive to $100 has been blamed on a number of causes. A falling dollar, tensions in Venezuela and Nigeria, relentless global demand.  All of these have no doubt played a role in crudes spectacular ascent.  But if all of these factors are the fuel of this bull market fire, there is another factor that served as the accellerant that made this fire "flash." That accelerant has been investor demand.

As we explained in past newsletters, it is investor demand that is driving crude prices ever higher as traders weary of real estate and punch drunk from the stock market seek an asset that is going to appreciate in value and hedge against inflation(see The New Fundamental in Crude Oil 11-19-07 at OptionSellers.com).

As billions continue to pour into hedge funds and commodity pools, fund managers need to place these funds into the market. As funds are typically long the market, what better market to buy than one with a solid fundamental story, huge open interest and media coverage that makes investors "feel good" about their investment?      

While these speculators are driving price, they can only disengage from fundamentals for so long. Often, benchmarks like the $100 level are good places for longs to take profits and for commercials to lock in a hedge.  If T-Boone Pickens is shorting the market here, we think the shorts might be in good company. But can long term bulls look to make profits from a correction against the trend? Of course.

Our purpose for these articles is to show you how to make money from markets moving in any direction. Longer term, it is hard to see oil prices starting a new trend to lower prices. Global oil demand is already at burdensome levels and continues to expand. Yet supply is fixed and producers are operating  at near maximum capacity. They can't "plant" any more for next year.  From a longer term standpoint, the bull should live on.

For the more immediate term however, this market is ripe for shorting - in particular, selling calls high above the current price of crude.

Our viewpoint stems from several factors.

1.       First, oil looks expensive when current stock builds are examined.  Thursday's  EIA inventory report  showed US crude inventories increased sharply last week - up 4.2 million barrels over prior week levels.  At 309 million barrels, this puts stocks at about even with the 13 year average. However, Unleaded Gasoline, the market some blame for pulling crude higher, has experienced substantial builds in stocks. US gasoline stocks rose 1.1 million barrels last week to 230.3 million barrels, the highest level for this time of year in 14 years. Gasoline stocks are now up  a record 15 straight weeks, and have risen 18.5% since November.  This has caused refineries to "scale back" production and refinery rates have dropped to their lowest level in nearly two years. This, along with imports rising back above 10 million barrels per day should allow crude stocks to continue to build over the near term.

2.       With gasoline now topping record price levels and the US economy tipping into recession, consumers may finally be crying "uncle."  MasterCard Advisors, LLC this week issued a report showing US gasoline demand in week ending Feb. 15 fell 4.4% below the same time last year - the largest one week drop since December.  This was also the fourth consecutive year to year decline.  With heating oil demand season nearing its end, it is typically gasoline demand that drives crude prices into the US Spring. With supplies already hefty and demand dropping- we think that high prices could be starting to cure high prices.

3.       OPEC production cut worries have been sighted by some analysts as helping to drive the surge over $100 per barrel this week.  In our opinion, this is an unfounded fear.  OPEC is keenly aware of the economic situation of it's biggest customer - the US. With the American economy teetering and oil's high profile price surge this week, we would think there is little chance of OPEC tightening the screws even further.  A deepening US recession is not good for business.

Bulls will cite Nigerian violence, refinery fires, or this week's Turkish incursion into Iraq as cause for further rallies. But these are typically one day wonders as this market is accustomed to production in violent places. The Turkish incursion will almost certainly have no impact on oil production.

No folks, this rally is spec led and it will be specs who lead the way down when liquidation time comes.  With prices still near $100 a barrel, longs will be reexaming their positions and some may decide to take a look at where supplies are right now. Doing so should almost surely cause some hesitation.

We're with T.Boone when we say prices are due for a $10-$15 per barrel break before picking up strength again in the second half of the year.  We don't however, see oil prices falling out of bed and a decent break should give longer term bulls a good opportunity to get long this market (longer term put sellers take note). Nonetheless, in the immediate term we see an opportunity to sell calls far above the market at the inflated premiums now available. 

Not sure how selling calls works? Do you see oil prices going to $120, $130, even $140 per barrel over the next 90 days?  If not, then selling call options at these strike prices may be for you.  Although premiums can increase in the meantime, as long as the price of oil is anywhere below these levels at option expiration, the seller keeps the premium collected as profit.  We recommend option selling to our clients for many reasons - one of them being that an investor can be wrong the market and still profit from his short option sale.

We'll be working closely with client portfolios over the next 7-10 days in identifying opportunities to sell calls in crude oil. We'll also be looking for opportunities to take profits on Unleaded Gasoline short put positions recommended last month.

Be sure to catch Bloomberg Television's video interview with OptionSellers.com's own James Cordier on Crude Oil prices from February 19^th, 2008 - Now available on the In The News page of our website. 

If you would like more information about selling options in the energy markets or building a portfolio based on the option selling approach, feel free to call or visit us on the web at www.OptionSellers.com< /strong> and request a free Option Sellers Information Pack.