Crude Oil Hits New High - How to Trade a Bull Market
It’s pretty clear when you look at the daily chart of June crude oil futures that this is a runaway market, hitting new all-time highs Tuesday, April 22 above $119 a barrel. Here's how you approach this market...
The news media seem to be searching for any excuse why this market is going higher to the degree it has, and the trade seems more than ready to push the market to new highs. For example, the market is not really paying attention to news of builds in supply, at least not as much as we’d expect, but it milks the dips in supply for all they are worth. It’s a bane to traders trying to pick a top.
If you look at the chart below, the Relative Strength Index (RSI) is at an overbought level which could signal a short term pullback. You’ll also note several colored lines on this chart indicating moving averages. The blue line is the eight-day moving average. The red line is a 21-day moving average. The green line is a 50-day moving average and the black line is a 100-day moving average.
You can see in the chart above that the market tested the 50-day moving average (green line) three times. That support held, and we continued to make new highs on Tuesday above $119 a barrel.
Picking a top in this market can be a dangerous proposition. I recommend using stops, or buying a put option. Buying a put option can define your loss to what you paid for the option, plus the cost of commissions.
If you want to buy on a long-term basis for an even higher move, I would look for opportune levels on declines to establish a position. Notice that the market hasn’t closed below its eight-day moving average since the beginning of April, even though it has followed it up and tested it several times. A close below the eight-day moving average, currently at the time of this writing, near $114.25, may incite a selloff to $110. Therefore, I recommend buying on any decline to $113.
Technically, this market could experience a $20 - $30 pullback and still be in an uptrend. I believe the days of $70 oil are gone, however.
Be sure to also keep your eyes on the fundamental news. The Department of Energy (DOE) reports the current crude oil supply (stocks) every Wednesday at 9:30 a.m. Central time. Last week, we had quite a dip in the stocks, which caused the market to rally quite significantly.
Short Strangle Strategy
Keep in mind that selling options is risky because the maximum risk is potentially unlimited. You take in a set amount of premium but expose yourself to unlimited risk. I preach safety over greed. A strangle involves buying or selling both calls and puts that are out of the money. To determine the value, you add the premium of calls and puts together.
Generally speaking, a trader that uses a short strangle strategy wants as large a range as possible, while also being able to collect a decent amount of premium. In the case of crude oil, earlier this month I recommended selling the June 85 put and selling the June 130 call.
At the time, this strategy collected a premium of 70 – 80 cents on the contract, which converts into $700 - $800 per strangle. The margin on this strangle at the time was $1,000, but due to the current volatility, the margin has gone up recently. However, due to the delta, which is the rate of change on that call option, the value has not increased significantly, which is good. The value of the put on the other hand, has decreased to almost nothing.
With a strangle strategy like this, it is important to continually watch the market, which is what I do for my clients. If the market gets to a certain point, we may need to adjust the position or liquidate, to avoid losses. If the market rises to over $123 in the short term, I may consider covering part of my position to eliminate some risk. Overall, we are just waiting for these options to expire so that we can collect the premium. These particular contracts, the June $85 put and June $135 call, expire on May 15, 2008.
As I mentioned earlier, executing this strategy requires you to get a large range with a decent premium. At this point, if I were to initiate a new client into this type of strategy, I would consider selling 135 to 138 calls, collect at least $300, then sell 91 or 92 puts and collect at least $300 there as well. With this strategy, you still have $15 to $20 on each side that the market can move back and forth between before hurting you. Because prices are constantly changing, this strategy may have to be adjusted at the time you are reading this. If you are interested in more current numbers for this strategy, you are more than welcome to call me at 800-993-6601.
Everyone has their own pain threshold. I try to make my strategies as painless as possible. Therefore, I usually draw a line in the sand where I want to get out of the trade. This is always an important risk management principle. Always have an exit strategy.
Tom Mikulski is a Senior Market Strategist with Lind Plus. He can be reached at 800-993-6601 or via email at tmikulski@lind-waldock.com.
Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.
*No representation is being made regarding the actual or hypothetical performance of the systems at any other brokerage firm or prior to the dates reflected above. These numbers include commissions, but not fees. Contrary to most published results, please note that these monthly returns are calculated based on closed trade profit/loss and do not include changes in open trade equity. Futures trading involves the substantial risk of loss and may not be suitable for all investors. Past performance is not necessarily indicative of future results. All information, including performance and program description, has not been reviewed or verified by Lind-Waldock.
