Interesting Week for Oil...This Time, I'm Playing for Real

Oil prices snuck higher today, but the real action should be forthcoming.

OPEC begins meeting tomorrow, and the usual troublemakers (Venezuela, Iran) are looking to milk some more money from their barrels. The cool, calm, and in-control Saudis will be expected to propose holding production steady. As oil rose exponentially earlier this summer, Saudi economists and oil ministers affirmed that they believed that $80-100 was a good price for oil, but as barrels begin to approach that range, they too may step up the rhetoric a little bit. Countries like Venezuela and Iran have called oil too cheap, but the Saudis control enough of OPEC production to really be the deciding party.

Though any big change in production is unlikely to occur, the degree of rhetoric may have some influence on market movements going forward starting tomorrow.

And as news outlets have informed you, there's another hurricane brewing in the Atlantic - Ike. Ike just crossed Cuba and weakened, and it will cross again, but at some point it will enter the gulf and (supposedly) begin to strengthen. Right now, the track takes Ike into the middle of Texas, a little south of Houston. If this forecast proves accurate, then oil and gas production will be disrupted.

Wednesday is the weekly inventory report, and the numbers will be a little funny due to our ol' pal Gustav. However, Gustav didn't affect production or refining to the extent that was originally expected (hence the big drop in energy prices after my post about it), so the numbers may be bearish.

With my funds, I took a long position via my favorite vehicle - Conoco Calls. Unfortunately for me, Conoco announced a big, expensive parternership dealing with Liquified Natural Gas in Australia last night, so COP shares fell while those of other oil companies rose today.

Last time I was dead wrong; Gustav was a dud (relatively speaking - unfortunately, peoples in ocean countries beared the brunt of the once-powerful storm). This time, multiple events will be in play. I'm taking the contrarian stance - it's in my nature, for better or worse - after energy prices and related shares have fallen dramatically over the past two months. A quick pop tomorrow, Wednesday, or anytime soon, and I'm out - I'm still not convinced that oil's true value is $108/barrel.



To follow up:

As oil shares crashed on Tuesday, I bought shares of COP around $70 and Marathon Oil (MRO) Around $41 as long-term purchases. It looks like crude and oil equities will open lower today, but oil companies are looking dirty cheap.

Follow up to COP/OPEC trade

Just to follow up, (and for the sake of full disclosure),

I closed my Strangle trade yesterday. ConocoPhillips (COP) moved up, the calls increased in value, and I sold the calls, netting a 16% gain in three days, including commission costs. I still hold the puts (which are now nearly worthless at 11 cents), which I could have sold to make another 3% gain. (I'm holding just so that, if COP falls, I might milk a little more money out of this trade.)

16% doesn't sound like much, but annualized, it was a 1920% return. (Also, if I would have traded more contracts, commission costs would have been lower per contract and the percentage gain would have been slightly larger).

This was a sort of experiment for me, and my "long strange" worked as planned. If you see the potential for volatility in a stock, this is a good strategy to consider.

Strangle OPEC, Make Money.

The fluctuating, inflated price of oil has held the attention of businessmen and lay people alike. Oil's price run-up has certainly been impressive; from a low near $10/barrel in the late 1990's, oil flirted with $100 just last week. This dramatic increase was only rivaled by the price spikes after the oil embargoes and crises in the 1970's and 80's. Just this year, oil is up 30%.

The cause of this increase is debatable. Sure, the incredible growth in China, India, and other emerging economies will strain the production capabilities of the world. But did it really merit such a dramatic increase?

I'll let professional economists and commodities experts argue over the causes and effects of $100 oil. But I think that the average investor can profit off of the volatility in oil.

Oil has retreated from nearly $100 to about $90 per barrel. But where will oil go from here?

Wednesday may be the day that clearly defines a trend. Two defining events will happen this December 5th. First, the weekly oil inventory report will be released, and this week's numbers could be effected by the pipeline explosion late last week. If inventories significantly declined at Cushing, the delivery point for the Nymex contract, that could be a catalysts for a pop back to $100.

The more significant event will be OPEC's meeting in the United Arab Emirates on the same day, this Wednesday, December 5th. Much of the developed world is looking for OPEC to increase production quotas to ease prices. However, with the recent 10% decline in the price of oil (the steepest and quickest in years), OPEC may not be motivated to hike their output. Unless a major event occurs tomorrow, I see oil staying stationary into the two announcements yesterday.

So two possibilities exist:

• On one extreme, US inventory was steady (or even increased) and OPEC decides to increase production. If those happened together, the price of oil may plummet.
  
• However, if inventories are pinched and OPEC deems current production sufficient, then the price of oil could be back near record territory, considering the market is already pricing in a production increase.
  

I don't know what's going to happen, so I chose to be insulated either way.

I set up a "Strangle" options scheme, using my favorite oil stock, ConocoPhillips. When the stock was trading around $80 today, I bought $75 puts and $85 calls. The calls were about half as expensive as the puts, so I bought twice as much. (Also, I have a tendency to expect upward price movement simply because the oil stocks have declined considerably recently.)

The puts were $63/contract, and the double-strength calls were $78 for two. The at-the-money calls and puts both trade for around $2/contract. So, as long as Conoco moves $5 either way, the transaction will be profitable. (If it moves to the upside, which I made a slight bet on, It'll be a little more lucrative).

Using a "Straddle" (at-the-money calls and puts with the same strike price) or a "Strangle" (out-of-the-money calls and puts at opposing strike prices) can allow a trader to profit off of the volatility of a stock, no matter which way it may move.

Since my crystal ball is out of order, I don't know if oil is going to be up, down, or flat on and after this Wednesday. But as long as something happens and oil moves in one direction, this trade should profit from an unpredictable market.