August 31, 2011 – Sell Oil for a Stock Hedge

Featured Trades: (SELL OIL FOR A STOCK HEDGE), (USO)


2) Sell Oil for a Stock Hedge. Over the last month, asset classes everywhere have downshifted to new, lower trading ranges, reflecting the very rapid chopping of GDP growth forecasts for 2011 from 4% to 2%. Oil is no exception.

I think the new range for Texas tea rises from the $75 low we put in on the August 8th melt down day to a high of $90. So I am going to use today's $3 rally in crude triggered by hurricane Irene to get some downside exposure through buying puts in the oil ETF (USO). There is no sign of any disruption of oil supplies or refining capacity whatsoever.

Keep in mind that oil is one of the most volatile financial instruments out there right now. It is also a great lead contract for all asset classes. In one week this month we saw two $12 moves up and down. This is largely due to high frequency, or algorithmic capital pouring into the area which has been driving traditional pit traders to despair.

Oil has its own particular problems. The end of the Libyan civil war is likely to bring 1.8 million barrels a day on to the market within 18 months. I happen to know that the western oil majors were not especially happy with the terms the Khadafy regime extracted from them. They were marginally profitable at best, and as we now know, were high risk.

A grateful new regime is likely to have different ideas. Not only will contract terms be more generous, production could be quickly ramped up to 3 million barrels a day, which the country has always been capable of producing. The offshore area in the Gulf of Sidra has huge potential, but has never been tapped. Capital demands for reconstruction, infrastructure, and deferred maintenance are enormous, so the need for new revenues is great. For the rest of us, this could all lead to lower prices.

Oil puts would be a nice hedge for the rest of your long positions as well. I may be early here by a few bucks. But when 'RISK OFF' hits again, oil will turn so fast that it will cost you $3 to get in. It could hit $80 in a heartbeat, leading to a potential double in the puts.

The only way you could lose money here is for the 'RISK ON' trade to continue, and for equities to move up in a straight line every day for the foreseeable future. That is something that I am happy to bet against. The markets are anything but finished with inflicting new tortures upon us, and September promises to be another volatile month.

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The Market is Anything But Finished with Us

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