Trader Expects Sandy to Rock the Oil Market
With Hurricane Sandy bearing down on the East Coast, traders are trying to figure out how energy markets will be affected.
One trader was positioning himself to take advantage of volatility in crude oil on Friday by buying the United States Oil Fund November 32-strike straddle for $1.85.
So what's a straddle, and what does it do?
(Read More: How Storm Will Affect Investors: 'Month to Remember'.)
Traders buy straddles when they expect an explosive price move but are unsure of the direction. Straddles are also very sensitive to changes in implied volatility, and profit when volatility increases. The bottom line is that this spread will profit if USO is above $33.85 or below $30.15 at expiration.
The NYMEX is closed on Monday, and could be closed again Tuesday. Ahead of the storm in electronic trading, crude oil is lower while gasoline and heating oil are higher. This is a result of East Coast refiners in Sandy's path getting shutting down, which means less demand for crude oil and less supply of gasoline and heating oil. (Read More: What Will Sandy Mean for Gasoline and Heating Oil?)
Crude oil has fallen considerably from its highs in September, mainly on fears of a global slowdown and excess supply. USO looks like it could be headed to the $30.00 level, which is near its 2011 and 2012 lows and is likely to provide support.
The bullish case for oil is that it is oversold, and those who bought into 10 percent or more declines have proved to be winners months later.
With all that said, is this a wise trade?
Indeed, for traders wanting a fixed-risk way to profit from the potential for large directional swings in crude oil over the next few weeks, this is the trade for you. However, you have to be willing to scalp stock around your straddle when USO moves.
Brian Stutland is the President of Stutland Equities and a contributor to CNBC's "Options Action."
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