18 May 2009

Oil Swing Trade

Here's the oil-based swing trade I have in the works.

First off, Tim Knight provided the first bit of inspiration with a post pointing out the breakout of ERY, the 3X-bear energy ETF:

Anyway, one interesting graph (which is my best dollar gainer today) is ERY, which I think has a pretty clear shot to $30.

Instead of trading ERX/ERY, or the 2X-levered energy ETFs DIG/DUG, or the XLE, I took a look at the options for each. The June 20 DUG calls seem to offer the best combination of liquidity, a tighter bid/ask than the ERY calls or XLE puts I considered, and, of course, the best bang for the buck if my call is correct.

Here's DUG's chart:

My price target for DUG is $23-$25. The sooner the better, but I'm looking out five-to-ten trading days. The bid/ask spread for the June 20 calls on Friday closed at $1.50/$1.70. Considering the down Asian markets and the down futures, let's see how valid these price points remain later this morning.

Mish offers up some analysis of the oil markets backing this position:

Gasoline Prices - Where To From Here?

Inquiring might be asking about gasoline prices in the short term. Let's consider some technical and fundamental factors starting with the following daily chart of crude prices.

$WTIC Light Crude Daily Chart

Tight Storage May Lead To Huge Oil Price Drop

Technically, crude prices are a bit extended, no doubt in conjunction with the belief the economy is recovery. A likely place for the rally to fail would be near the 200 Exponential Moving Average (EMA) in red. Moreover, there are a number of fundamental reasons for the rally in crude oil prices to falter soon.

Please consider Tight storage may lead to huge oil price drop.
The present contango in oil prices bears all the hallmarks of an oil market where supplies are well above present fundamental physical consumption.

The recent large inventory build of petroleum, under a steep contango which now is flattening, within the big oil consumers (like the OECD countries and China) have left some with the expectation that major economies soon will begin to grow again, and that the contango now signals increased oil demand and higher oil prices in the future.

My analysis indicates that in recent months, as much as 2 -3 Mb/d of global petroleum supply has been used to build inventories. This is about to come to an end, because available storage is getting closer and closer to full and contango has begun to flatten. When additions to storage cease, the resulting drop in demand can be expected to lead to substantial downward pressure on oil prices.
All things considered, oil prices are due for a pullback and gasoline prices at the pump are likely to follow. Moreover, with the possible exception of food, consumer prices in general will remain under pressure, if not indeed negative on a year over year comparison basis for quite some time as well as falling producer prices pass up the chain.

I did say that I had a swing trade in mind. I still have my eye on going long OIH but now I'm prefer to see my long DUG calls earn some profits that I can pour into OIH if OIH falls back toward the top of its previous trading range, around $87-a-share.

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