Looking out 2-3 months, with WTI crude in the low $90s, I think we're likely to stay relatively range bound ($80-110), but I also feel we're closer to the low end of range than the top.
I would characterize my sentiment as fairly agnostic with underlying bullish tendencies.
I believe that the festering issues in the Middle East will persist. I think that regardless of who resides at 1600 Pennsylvania Ave there is a greater likelihood of tensions increasing than decreasing (ergo underlying bullish leanings).
I'm of the opinion that the reflationist efforts of Central Bankers from here to Shanghai will continue. The race to debase has no end in sight, which from a textbook standpoint ought to be supportive of things like Energies and Metals. I also believe the unintended consequences or potential collateral damage of constant intervention could also be considerable.
In other words, TAIL RISK EXISTS regardless of how complacent the markets becomes in the short term. Just because realized S&P vol over the past 30 days is close to single digits does not mean that the systemic risks that rattled confidence repeatedly over the past 4 years have disappeared.
(Have you ever tried to keep a beach ball underwater?)
Implied vols in WTI have vacilated between 25% and 35% for most of the past year.
Looking out 60-90 days and considering trading opportunities that reflect my sentiment I would consider the following:
FEB CL (underlying ~$91) options expire on 1/16/2013 or 86 calendar days from today.
SELL the 110 call and SELL the 70 put to collect ~$1.10 ($1,100 less commission). This is a short volatility (short ~34 vol) range bound play that benefits from decay (theoretically) and Crude prices remaining above $70 and below $110. The MOST you can make on any short strangle is what you collect (less frictional costs) and I would NOT recommend holding the position until expiration. In my mind, you should try to take 75% or so of the premium collected out of the position.
This trade has unlimited risk.
At expiration, your break-even levels (excluding commission) would be $111.10 and $68.90.
This trade requires $675 in initial margin, but that can go higher if Crude moves quickly.
It has almost no delta sensitivity as of today.
Alternatively, consider a position with more room to the upside.
FEB CL
SELL the 115 call and SELL the 75 put and collect ~$1.35 ($1,350 less commission). Also short volatility, range bound play where the most you can make is what you collect. This position has expiration break evens (excluding commission) of $116.35 and $73.65. This trade has an initial margin requirement of $1,330 and that can fluctuate.
This trade also has unlimited risk.
The profit objective would be about $800 in the first example, and roughly $1,050 in the second example.
Here's where it potentially gets a little confusing. While I believe we're likely to stay relatively range bound +/- $20 in WTI over the next few months, I would like to also have some "soft long deltas".
Here's what I would do to express my underlying bullish sentiment or to somewhat hedge the potential breakout risk on the topside (Middle east risk flare).
Consider using January Crude options, which expire on 12/14 or 53 calendar days from today.
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BUY Jan Crude 101 call and SELL Jan Crude 79 put and COLLECT about .05.
This position is BULLISH. As of today, it has a "soft" long delta of about 30, meaning for every dollar move in CLF13, the options spread (risk reversal) should (theoretically) get better by $300 (on the upside) and worse by $300 (on the downside). Those dollars get bigger the further it moves (delta sensitivity gets greater both ways).
At expiration (Dec 14th), this thing only makes money if CL is over $101 and only loses money if CL is below $79.
6/28 lows on CLF13 = $79.69
9/14 highs on CLF13 = $101.19
In March CLF13 got up toward $110.
Recap, I would consider ONE of the TWO aforementioned short strangles. If you are concerned about upside potential, which makes sense given geopolitical environment, you could pair the short strangle with a Long Call/Short Put in Jan Crude which kind of hedges your upside risk until Dec 14, at which point I would consider closing the strangle or replacing the soft long deltas depending on the state of the world in mid December.
Feel free to call and discuss. These ideas are not exactly cut and dried, especially when used in tandem. There are a number of moving parts, but I believe the potential risk outweighs the potential reward assuming you share a relatively range bound outlook with greater potential for upside breakout.
(I would consider similar range bound with bullish "hedge" plays in Silver as well)
By. Kevin Davitt, Global Execution and Futures/Options Broker
