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Commodities Roundup: Crude Oil-High Prices should

Commodities Roundup: Crude Oil - High Prices should not deter you if Selling Puts

James Cordier, Michael Gross, OptionSellers.com
April 8, 2011

Crude oil stocks remain near historical highs in the US. But that hasn't mattered to oil traders for several months now. Fear continues to drive this market and that does not appear to ready to change anytime soon.

OPEC produces nearly 40% of the world's oil with the overwhelming majority of that production coming from the Middle East. The recent overthrow of Egyptian regime followed by the UN support of rebels in Libya has emboldened opposition groups from Yemen to Syria to Saudi Arabia.

Instability in the Middle East alone will likely keep a floor under crude prices in the near term.

Saudi Arabia and Iran alone account for about 18% of the worlds daily oil production. Violence here would undoubtedly have a severe impact on oil prices. However, even minor disturbances in smaller producing nations have shown they have the potential to have a radical impact on oil prices - courtesy the speculator. Libya produces 1.8 million barrels a day when functioning at full capacity. It is estimated that about 80% of that is currently offline. This is about 2% of the world total, and is already being made up by other OPEC nations. And yet, prices have rallied nearly $15 per barrel when the violence began. What happens when another small disruption occurs in a Yeman, Oman, or Syria, let alone an outbreak in Saudi Arabia? Unless a spontaneous peace breaks out across the middle east within the next 30 days, expect a "fear floor" to support prices for some time. This is not to say that another spike higher in oil prices is in the cards. It does portend that the risk of a large move appears to be on the upside at this time.

Tis' the Season

Crude oil, however, has another factor currently working in favor of strong prices. The time of year.

On the wholesale level, seasonal demand for Gasoline typically surges in the February -May time period in the northern hemisphere as distributors accumulate inventories in order to have enough supply on hand to meet summer demand needs. Driving season in the US and Europe brings a surge in gasoline demand at the retail level. But the wholesale demand surge comes in the spring, when distributors buy. This creates higher demand at refineries for crude oil as they ramp up production to meet distributor demand. This often results in price strength that can last deep into the summer driving season.

Despite the current wars in the middle east and the recent disaster in Japan, global oil demand shows little sign of slowing. World crude demand rose by 2.4 million barrels per day in 2010 an is expected to increase by another 1.6 million barrels in 2011. Chinese demand alone rose 10.1% in February 2011, compared to the same period last year. While no hard data is available yet, it is expected that Japanese imports of crude will spike in the coming months as power taken off line by the crippled nuclear reactors will have to be replaced.

All of this, of course, does not necessarily mean crude prices will continue to climb. The crude market has experienced a meteor like rise and will be vulnerable to corrections in the coming weeks. The Mid Eastern situation is a fluid one and could bring any number of outcomes. The European debt crisis is making it's regularly scheduled monthly appearance as fears that Portugal will now need a bail out will give global recovery bulls pause and possibly slow the dollar's decline.

However, with one middle eastern government already overthrown, a second in serious jeopardy from NATO jets and civil unrest seemingly spreading to many others (Kiplingers reports this week that civil war in Yemen is a likelihood), bears will be hesitant to press the downside. This is especially true given the approach of peak demand season.


The least likely scenario would seem to be a downward spiral in prices. If this is true, then the highest probability trade would be selling puts in crude oil. With attractive premium still available in the $65 -$75 strike price range, sellers can benefit if prices continue to climb, remain stable, or even experience a moderate correction.

We will be working with managed portfolios is securing the highest premiums for select strike prices. If looking to sell these on your own, we suggest the late 2011 contracts for the best premium to out-of-the-money ratio.

Note: The opinions presented here are that of Liberty Trading and not necessarily shared by Optionetics and/or its instructors.

James Cordier & Michael Gross
Contributing Writers, Liberty Trading Group/Optionsellers.com
Optionetics.com ~ Your Options Education Site