Oil Services vs. Crude Oil

05/31/2013 7:00 am EST

Focus: STOCKS

While crude oil has been trading near its lowest price in a month, oil services stocks look bullish, so Greg Harmon of Dragonfly Capital offers a pairs trade idea.

Oil services stocks (OIH) have looked good as a group lately, especially the large-cap names. But with a volatile market, it has been difficult to find the right entry without getting stopped out. One way to deal with this is to enter using a pairs trade.

A ratio that I track, the oil services ETF (OIH) against the United States Oil Fund (USO) offers a good trade opportunity. The ratio below shows a breakout of the blue box of consolidation and some separation from the 61.8% Fibonacci retracement of the fast move lower in 2011.

The next Fibonacci levels at 1.415 and then 1.478 are good initial targets. The relative strength index (RSI) is supportive of a move higher and the moving average convergence divergence indicator (MACD) looks to be ready to turn higher in support as well.

chart
Click to Enlarge

Using 100 shares of OIH long against each short 135 shares of USO with a stop on the ratio below 1.31 gives a reward to risk ratio of 2.5:1 to just the first target. Put another way, this trade nets $250 at 1.415 vs. a loss of $100 if stopped out.

By Greg Harmon of Dragonfly Capital

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