A Crude Play on Uncertainty

07/11/2013 8:00 am EST

Focus: OPTIONS

Andrew Giovinazzi of OptionPit.com offers an options play on concerns about the energy supply, which can  give traders an opportunity to benefit from a highly-volatile market.

Alcoa has the record Tuesday for adding the most market cap to broad market equity prices following just a ho-hum earnings report. With a shortage of news and not much happy going on in Europe the only thing to make the market rally was good old AA. Did anyone notice the VIX got to near 14% yesterday? We have to go all the way back to the pre-ending QE days to see a VIX around 14.25. My guess is if it breaks 14, stocks will have shaken the QE blues away. Stocks, if anything this year, have been a poster child for resiliency. A possible monkey wrench might be the rally in oil.

I don’t get it. Not that I understand everything with commodity prices but this one is a bit of a surprise. Oil is at six-month highs just when the USA is on the verge of producing more oil than ever and eventually becoming a net exporter. Supplies are out there yet something is keeping the prices up. The chaos in Egypt is not helping. Leave it to some Middle Eastern mess to jam up the price of oil. Looking at the IV chart below there is some curious action. Namely IV is going up with the price of the underlying. That almost always means there is more to come at least in a realized volatility sense.

chart
livevolX® www.livevol.com
Click to Enlarge

Something is up and option prices are starting to fly so on balance there are more buyers than sellers of options in the oil complex (using USO as proxy). The USO was trading 31.4 in April and now it is over 37. The market is a bit confused on the rally since they would crush the IV if it was more certain on the direction. That feels like a modified strangle to me. I don’t know who is going to end up running Egypt but every day the country stays in the news the more oil is going to rally. It has moved a good part of the way already.

The Trade
The August term looks best and buying an upside call spread (Aug 37/40) with a just OTM (Aug 36) put would be a good way to trade the uncertainty in the oil market. When the IV starts to come in, the market is picking a direction so just hold one side.

By Andrew Giovinazzi, Chief Options Strategist, OptionPit.com

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