If investors were given a crystal ball at the start of 2023 and told that the conflict in Ukraine would continue, stocks would soar and a recession would fail to materialize, they would be undoubtedly be bullish on the energy sector and oil prices.
Unfortunately, even psychics can get it wrong. Crude oil prices remain virtually unchanged in 2023, currently at $76 a barrel.
Granted, there have been some negative factors pushing down oil prices. Principally, the much-awaited growth associated with the Chinese reopening has fallen flat.
Nevertheless, the crude oil market remains extremely tight, with Saudi Arabia recently announcing further production cuts to support prices and the U.S. Strategic Petroleum Reserves at the lowest levels since 1983.
For investors bullish on oil, they can buy either oil stocks, an energy ETF such as Energy Select Sector SPDR, or for direct exposure buy U.S. Oil Fund, which holds oil price futures. Specifically, it tracks U.S. light sweet crude oil.
However, with volatility low, a call option on the oil fund may be a good bet.
Buying A Call On USO To Bet On Oil Prices
With USO trading around 68, investors can consider a 75-strike call option with a Sept. 15 expiry. This call currently has a cost of $1.05, which also coincides with a maximum loss of $105 if USO remains below 75 at expiry.
For USO to reach 75, oil prices would need to rally around 10% from current levels. Hence, investors will still lose out if oil has only a modest gain over the following two months.
However, the profit on the call in the event of an outsize move is unlimited. An extreme move seeing crude oil rise to $100 by Sept. 15 would see USO likely around 89, which would generate a 1,300% return on the option.
Notably, USO does not need to even reach 75 for investors to take a profit so long as the move happens early, with ample time left until the expiration of the option.
However, every day that passes without USO making a move, the options time value (or theta) will decrease. That would result in a lower premium and investor losses.
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The annualized volatility for September's options is currently at 29.5% — below the 32% and 35% realized volatility over the past 30 and 200 days, respectively.
While crude has remained rangebound this year (Relative Strength Rating of 26), prices have been rallying lately and are up 6% in the last five days.
