It's time for the second step of our Spring Break Oil Trade... and I know it's going to hurt.
Here's what's been happening over the past five weeks.
Oil prices slipped as the Dow dropped below 13,000. Dropping below this level put a lot of fear about the economy into play, and that means demand for oil dropped. Oil inventories have climbed for the past seven weeks.
Wednesday, the Energy Information Administration found crude inventories climbed by 4 million barrels...
But here's what's been so surprising. After more than a month of supply increases, oil has maintained prices well above $100 a barrel, and has been consolidating around $103 for the past few weeks.
This is because globally, supplies are actually pretty tight... and we're using refined oil products like gasoline and distillates like crazy.
While our crude inventories have climbed over the past seven weeks, gasoline supplies have fallen for the past eight weeks. Distillate inventories have fallen sharply since March 16, from 136.6 million barrels' worth to 125.9 million barrels.
The recent stock rally and comforting Fed announcement (depending on how you read it) are keeping oil prices high.
Chairman Ben Bernanke said, "We see monetary policy as being approximately in the right place at this point. Our intention is to maintain highly accommodative stance of policy for the foreseeable future."
This means the Fed won't be raising rates any time soon. This is a double-edged sword. Low rates give the economy a break (in the short term), but also keep the dollar's value low – which pushes prices up for dollar-denominated commodities like oil.
This is very encouraging for oil bulls. And analysts are pretty bullish. Consider this from Citi:
Our base case assumptions for the second half of the year include both stronger seasonal demand and lower [Organization of Petroleum Exporting Countries] production. This would be consistent with either a scenario where Iranian production declines moderately, or one where Iranian production stabilizes but other OPEC production is reduced to help limit a drop in price on an easing of tensions.
But this "help" is a bit further down the line.
Oil prices have been consolidating... not pushing sharply higher. This stagnation hasn't helped our Spring Break Oil Trade. Over the past few days, oil prices have rebounded from around $102 a barrel back above $104. That kind of move should be sending our USO June 42 call options soaring much higher.
It's not.
And now it's time for the second step of the Spring Break Oil Trade.
Remember, here's how the Spring Break Oil Trade works. It's a simple three-step process.
Buy oil in the third week of March.
Sell half the position in the last week of April.
Sell the rest during the last week in May.
Action to Take: Sell half of the United States Oil (USO:NYSE) June 42 call options at market. Hold the second half until the last week in May.
These call options have fallen well below our entry price and haven't made the same comebacks as the USO or actual oil prices have.
Selling half means the second half of the position will have to work hard to make up this loss, but it also means you could be limiting losses should the play keep heading south.
But I think we're heading higher. Let's look at that chart again.
Oil prices are clearly coiling deep into this triangle formation. That's going to force prices to break out higher or lower soon.
Here's what DailyFX had to say:
Prices remain wedged between resistance at 104.90 and a rising trend line support set from mid-December, with a Bullish Engulfing candlestick pattern arguing for an upside bias. A break above 104.90 exposes falling trend line resistance at 106.25. Support is now at 101.78.
If oil can maintain this week's momentum, then we should see a breakout in the next couple of trading days.
And that should get our USO calls moving higher again.