Let's open with a word about some open trades.
Last week we recommended a zero premium trade that pitted Exxon Mobil against the United States Oil Fund ETF (NYSE:USO). We bought and sold equal numbers of July PUT options on each for the same price.
A week later, those same options are trading with a nice spread. The XOM July 80's are going for $2.55, and the USO July 38's are fetching $1.76. Almost $80 is now on the table today for each pair traded.
We see more upside for the trade, but we're advising those of a more risk-averse bent to take profits here. Forty or fifty pairs traded on no money down, now pockets you somewhere close to $4000.
Those who want to ride this trade further (it's only been a week, after all) should be prepared for zigs and zags, but a profitable outcome looks inevitable over the short term. Keep a close eye, too, on the Middle East, where a heavy government hand in places like Saudi Arabia, Iraq and Iran will likely keep a lid on any further upward oil pressure. Not a nice thing to admit if you're rooting for the anti-government forces, but a fact of investment life nonetheless.
We'll also continue to monitor the trade and keep those with a greater appetite for risk apprised of our thoughts.
The second trade on the dock is the Valentine's Day calendar spread we initiated on the S&P 500. We sold the February 1330 PUT for $6.90 and, as expected, it expired worthless, giving us full credit for the opening leg.
The second leg was a long position in the SPX April 1330's which are now trading marginally higher than our purchase price of $32.20 at $34.40. With the SPX now at 1321.15, the options are almost $9 in-the-money with a $2.20 profit and roughly seven weeks 'til expiration.
We'll be looking again to sell PUTS against the long position as the March expiration draws nearer.
In the meantime, however, we're holding.
Speaking of Oil and the Broad Stock Market
There's good reason to suspect that those Middle Eastern governments expecting rebels to up the ante in the face of apparent successes in Tunisia, Egypt and Libya, won't hesitate to act brutally to quell any hopes of regime change in their own backyards. They'll do this (as our intrepid upstart, Matt McAbby, wrote in last week's Bourbon & Bayonets) as much to reassure the West that the oil will continue to flow, as to send a message to locals that they ain't going nowhere.
Moreover, as the renegade McAbby suggests, the U.S. has given a green light to these nations to act without restraint in the event of any threat to wells, pipelines, refineries or other resource related infrastructure.
What McAbby fails to mention, however, is that the same logic holds true in reverse: that it behooves the rebels to blow up that same infrastructure as a means of ensuring NATO (or whatever U.S.-led coalition emerges) intervention – and then pressuring for a politically favourable solution at the U.N.
So it really is all about the state of the pipes.
In the meantime, the cost of today's oil spike in terms of %GDP has been relatively small. (So far, that is. It's not clear the situation is altogether behind us. It may well continue for some time.) Take a look here:
What is clear, however, is that higher oil prices are taking the wind out of consumers' and industrial producers' sails. And at this phase of the recovery, that appears to be the only thing stateside that could derail increasingly good news emerging on both the corporate and economic fronts.
Better Posture
Our focus at this stage is now changing, albeit slowly, from the inevitability of a deep market decline to the increasing likelihood of an imminent surge in equity prices.
How's that?
Well, it's still very possible that the broad market will experience a sell-off – even a deep one that scares the polka dots off Annie but doesn't do any lasting damage to her breeches.
The potential exists to see the S&P slipping to the 1180 to 1220 range. See here:
As the chart shows, price action is now huddled around the long term trendline, currently in the vicinity of SPX 1310. If support fails here, we see a drop to 1220. At that point, we'll re-examine the situation, but it's near certain that 10% will be slashed from recent highs at 1344.
If we're wrong, we're right!
Our bearish stance on the market, as we stated earlier is not something we're wedded to, and indeed, we see convincing signs of growth in both the U.S. and Europe – especially Germany.
Europe is still contending with a rat's nest of debt issues in Greece, Portugal and Ireland (to mention only three), whose sovereign bonds seem ever the target of spitting, selling, downgrading, court-martialing and sending to the Russian front.
But it's also likely the worst case scenarios for all three of these lending lepers have been discounted, and it's only Spain's future that remains a true question mark.
All that by way of saying that the two participants in the current investment cage match are very clearly the U.S. equity market and oil. If one rises the other falls.
How long this particular market topography will be with us is anybody's guess, but it obtains today, and it's also tradeable.
Here's another piece of chart-sense that adds to the urgency of the call. It's a chart that correlates the S&P 500 with crude over the last two years.
Very clearly, oil has been overbid of late, and at current prices is blowing gale force winds in the face of the stock market.
Someone's gotta give.
Our Trade!
We're going with another zero premium trade this week that plays the oil/equity relationship as it now stands.
On one side of the ledger, we're buying PUTS on the S&P 500 (NYSE:SPY) and selling PUTS on the world's biggest integrated oil producer, Exxon Mobil (NYSE:XOM). We're betting that if the stock market falls, it will fall faster than XOM.
On the other side, we believe that if the market rises, it will be because oil is backing off. So we're also buying CALLS on SPY and selling them on XOM.
Here are the prices and strikes. Feel free to go both ways, or pick a 'straight' bull or bear bet on the stock market.
Wall Street Elite recommends a bi-directional zero premium trade with the following specifications:
With kind regards,
Hugh L. O'Haynew,
Analyst, Oakshire Financial
