Oil Plunges as Iran Nuclear Deal Achieved – How to Lock It In

Oil has plunged back to $51 as a deal is reached with Iran.  

First Cuba, now Iran and we’ve pulled out of Iraq and Afghanistan – no wonder Fox is freaking out and calling this a complete disaster – it certainly is for the Defense Industry (ITA) (XAR).  Hopefully Trump can start a war with Mexico so we can get our beligerance back on track because it’s getting pretty dull out there under Obama.  

We called a bottom on oil at $51 in our Live Member Chat Room this morning and already it’s up at $52, which is a quick $1,000 per contract gain already.  We don’t think oil will come ripping back but $50 is likely to hold and $55 is probably the right price, overall.  That means it’s a good time, which the VIX is still high, to sell some puts on the Oil ETF (USO), which is down around $17.50 after bottoming out at $15.61 in March, when oil was down around $45. 

Since we think $55 is the right price for oil (about $19 on USO), then selling the Jan $17 puts for $1.50 is a no-brainer.  Selling 10 contracts puts $1,500 in our pocket and obligates us to buy 1,000 shares of USO for $17 ($17,000), which is net $15.50 on it’s own and an 11.5% discount off the current price.   If you are a typical consumer using 750 gallons of gas per year, that’s like giving yourself a $2 per gallon discount.  

What you are doing with this kind of trade is locking in the low prices on oil and gasoline while it’s down and, if oil prices stay flat or go up – you keep the $1,500 and the contracts expire worthless in January.  If oil prices fall further, then you are obligated to own 1,000 shares of USO but they then become a long-term hedge against rising fuel prices while your actual savings come every day at the pump.  

This is similar to the strategy we laid out for our Members at the beginning of this year with “Secret Santa’s Inflation Hedges for 2015” though, at the time, we liked the Energy Sector ETF (XLE) as an energy hedge and our trade idea on December 21st was:

XLE is the ETF for the energy market and it’s currently trading at $80.57.  If you want to guard against a $1,000 increase in the price of fuel next year, you can, very simply buy 2 Jan 2016 $75/80 bull call spreads for $2.20 ($440) and offset that cost with the sale of 2 2017 $50 puts for $2 ($400) for a total outlay of $40.  If XLE simply maintains $80 for the year,  you make $960 (2,400%).

XLE has actually fallen further since then (now $74.01) as fuel has stayed cheap, so the hedge wasn’t needed to offset price gains.  That doesn’t mean we lose money because we are following our core strategy of “BEING THE HOUSE – Not the Gambler” and the short $50 puts have fallen to $1 ($200 for 2 contracts) while the Jan $75 calls are still $3.15 and the short $80 calls are $1.35 for a net of $1.80 ($360 for 2 contracts) for a net of $160 from our $40 open.  

That means that hedge is up 300% in just over 6 months EVEN THOUGH OUR PREMISE FAILED!  That’s what BEING THE HOUSE is all about – we sold the premium risk to others so we KNEW that time would be on our side – even if the actual movement of the ETF was not.  

IN PROGRESS

Provided courtesy of Phil’s Stock World.