While the crude oil market stabilized quickly after the initial shock of the attack on Saudi Arabian production facilities, one options trader is anticipating more upside, reports Jay Soloff.
Last week was supposed to be all about the Federal Reserve’s Open Market’s Committee (FOMC) meeting. The September FOMC meeting was the first since July, and quite a bit was riding on what the Fed decided —though the quarter point cut seemed mostly baked in.
However, the Fed’s thunder was stolen by an unexpected asset, oil. The drone strike on Saudi oil facilities last weekend grabbed headlines as the price of crude oil spiked as soon as the futures markets opened.
First, some background: A group, likely backed by Iran, attacked an oil production facility in Saudi Arabia using drones. The ensuing fires shut down half of Saudi’s oil production output or roughly 5% of global oil production. The result was about a 15% one-day jump in crude oil prices.
However, Saudi Arabia recently announced that full production would resume by the end of the month, and crude futures backed off. There have been conflicting reports regarding how soon Saudi Arabia can return to full production, and that is not taking into account potential retaliation and additional attacks.
So, is this disruption going to result in any lingering effects on the market? Is there more concern in store for oil? There’s certainly been a substantial amount of activity in United States Oil Fund (USO).
USO is the most popular ETF for directly trading oil prices. It is based on oil futures rather than oil companies. On the day of the Saudi production restart announcement, USO traded almost 100 million shares (90-day average 30 million) and nearly 400,000 options (90-day average 115,000).
Looking at the options action shows mixed results. Indeed, the production shutdown was bullish for oil, while the production restart is bearish. But what's next for USO?
Well, there’s at least one very large trader who is bullish on USO (and oil prices in general). This trader bought a massive amount of covered calls on USO which expire in October.
More specifically, the trader/fund bought 1 million shares of USO for $12.30 while simultaneously selling 10,000 Oct.18 15 calls for 7¢. Why sell a call for 7¢? Well, that does work out to about a half percent yield for a month, or 6% annualized.
Considering that USO doesn’t pay a dividend, why not make some extra cash while holding the shares? Another possible reason is that USO charges a 0.45% expense ratio (a normal amount for this type of product) and that half percent yield basically covers the cost for buying all those shares.
Meanwhile, the trade doesn’t cap out USO stock appreciation until $15. That amounts to over 20% upside potential in the stock at max gain ($15 or above). As such, this is clearly a bullish trade. The buyer is leaving plenty of upside potential open while just receiving enough yield to amount to a small dividend (or to cover the expenses).
If you’re bullish on oil and want to do a similar trade in USO, you could also increase the trade’s yield by selling a call closer to the stock price. For example, the Oct. 18 14 call trades for 14¢, or double the price of the 15 call. That works out to a full percent yield over a month and still allows for over $1.50 worth of upside in the stock.
Jay Soloff is the Options Portfolio Manager at Investors Alley. He is the editor for Options Profit Engine, an investment advisory bringing you professional options trading strategies, with all the bells and whistles of Wall Street, but simplified so all you have to do is enter the trades with your broker.
