TAMPA, Fla. (Liberty Trading Group) –- The recent plunge in crude oil prices has come as a welcome relief to U.S. and world consumers who were starting to get accustomed to $75 per barrel oil. In a market that was fundamentally overpriced, it seemed only a matter of time until the market shrugged off political events that could eventually pose some type of supply threat in the future and began focusing on where supplies are now. This meant the market had to finally account for U.S. crude supplies at seven-year highs.
It is a testament to world oil producers that this U.S. stockpile in crude was able to be built in the face of record worldwide demand. OPEC was happy to pump as much oil as possible at $75 per barrel. Now with prices hovering near $60 per barrel, the powers that be within OPEC have decided that a production cut may be in order.
This week brought news that OPEC had reached a “consensus” on a production cut of 1 million barrels per day. This would represent a 3.4% cut to total OPEC production which currently averages about 29.47 million barrels per day.
A consensus, however, is not a formal agreement. The U.S. has made it plainly clear that it opposes any type of production cuts. Falling gasoline prices are one of the few things the current administration has going for it heading into fall elections. Although Venezuela and Iran could probably care less if the U.S. opposes cuts, the Saudis would generally prefer to keep things on an even keel with their American trade partners.
Saudi Arabia is by far the world’s largest producer and exporter of oil and carries the biggest weight within OPEC. The Saudis’ good relationship with the current administration is well documented, and their willingness to do their part to help out should not be underestimated. It is for this reason that we expect any type of production cuts to “take time” as the Saudis drag their feet on a formal agreement until after the U.S. elections.
However, pressure from other OPEC nations will mean the Saudis will not be able to stall forever. We expect more dialogue in the coming weeks building up to some type of production cut in November.
In the meantime, oil prices appear to be probing for a low. While energy prices tend to make seasonal lows in December, this year has not been a typical year for crude oil or products. Energies are still following seasonal norms to some degree but appear to be about a month ahead of seasonal price tendencies. If this continues to be the case, we would expect a major low to be established in crude oil over the next 4-6 weeks, roughly coinciding with some type of OPEC production cut and heading into the high-demand U.S. winter.
While we don’t see prices moving decidedly higher within the next 30 days, we think the implied volatility in the December puts will present some solid opportunities for selling these options for premium in the coming 1-3 weeks.
For traders not familiar with option selling, selling a put allows a trader to profit regardless of the market moving higher. For instance, if a trader sells a crude oil 53 put for $500, as long as the crude market is above $53 at option expiration, the option expires worthless and the seller of that option keeps the $500 as profit. Selling the put in some circumstances can contain the same amount of risk as buying a futures contract and one should be comfortable with such risks before selling the options. However, there are many effective ways of managing and/or limiting this risk, which can allow even a timid investor to utilize this high-percentage strategy.
Crude oil appears to be reaching a value level at current prices while the fundamental outlook is gradually taking on a decidedly more bullish tone. We would be inclined to begin selling the occasional high-priced put option in crude over the coming weeks with an eye toward establishing a major position after the fall elections.
Copyright © Liberty Trading Group 2006
James Cordier is head trader and president of Liberty Trading Group, a futures brokerage firm specializing in option writing on commodities. Michael Gross is an analyst with Liberty Trading Group. If you would like more information about the option selling philosophy or building a portfolio based on the option selling approach, please feel free to call (800-346-1949), e-mail or visit us on the web.
