I entered a small position on Oil when it first dipped below $40 and I just today added more to my position when it broke below $35.  I will continue to cost base down on big moves and I will roll the date if I get to within 4 or 5 months of expiration.  This strategy is a break even on any bounce back to $37 or less based on time and how low things go.

I have stated this in the past but its good to revisit it.  My strategy is usually to find oversold stocks with a lot of negative sentiment around them.  Options do not track the underlying stock with a black and white value based on time.  Stock sentiment has a factor as well, momentum stocks for example typically have a much higher premium on the future calls than stocks that are really negative.  To make money on options you have to overcome the premium you paid to get the leverage they offer.  You can actually see this in action if you look at a stock that is on its way UP during a big run, say its X, the future option action is say 100.  But on its way down based on some negative news it may trade at X again but the same option can be say 80.  So if your time horizon is long enough out, say 1 year, time decay is not really hurting you too much, the value of the option can be somewhat “emotional”.  (There are technical terms to quantify this that include the delta, gamma, vega and theta… go research if you want.. my reference to emotional is the “vega” in nature)  Most professional traders wait for a floor and a bounce before they buy a stock.  The problem with Options and that strategy is you then have to pay the premium of the positive sentiment.  Trying to catch a falling knife means you can get cut, but if you are committed to the trade and cost base down with a plan, you can maximize your returns and minimize the risk.

Here is why I think this Oil play is a good return on the risk…

I am buying the Jan 2017 $15 strike on USO.  Tracking WTI is not perfect with USO but its close enough for my purposes.  At $15 USO tracks to WTI at around $46/7.  Note I don’t think its going to get above $47 by next year, it doesn’t have to.  I will sell or roll long before that date gets too close, I pick 15 because to me its the sweet spot, far enough out of the money that its cheap but within the window of any bounce to get a return.  Remember I am looking for 2x, 5x, or greater returns.

Lets explore worst case (lose all or most of my money):

My version of a worst case is Oil drops to the mid $20’s and stay’s there till August, this option position will be worth 1/2 maybe 1/3 of what it is now as I will cost base down every $5 move on WTI.  I would then be forced to roll out an additional 6 months, that will cost about 25% if I stay on the same strike, or it would be even if I go farther out of the money.  I could repeat this strategy probably 2 more times before I go to zero.  Each time of course Oil has to recover to a higher point for a break even but that is saying Oil will not hit $45 in the next 2 years?  I’m comfortable with that bet.  Any spike back up to the Mid $30’s within a year with this strategy would allow an exit at even or a profit.

Lets explore my version of a likely event (close to break even, slight profit)

Oil drops to the low $30’s and stabilizes, I cost base down again when its close to $30 and wait.  It might be a painful Q1 but as we come out into Q2 we start to see a slow recovery and momentum shift.  So even though the price may be the same, sentiment will now be positive or at least not so crazy negative as it is now.  On any sort of spike I can likely break even or take a modest profit next summer.  Remember the additional capacity from shale plays in the US are not an instant on, instant off scenario like a lot of other Oil in the world.  The market is constantly surprised that production in the US has stayed so high in the face of low prices, but it takes time, many months, and for some plays years, for them to play out.  Once things are flowing it makes sense at almost any price to continue the project.  But there is no question that new project activity has fallen off a cliff, that will eventually re-balance the market above $40.

Lets explore the upside of the bet.

If Oil in the next 9 months gets back to $50 this play will 5x in value, if it went to $60 it would be crazy, 20x or more in value.  And what scenario’s could  take Oil back to those (historically modest) values?  Long shot, but Opec (Saudi’s, Iraq, Iran, Russia) could come together and slow production, agree this is unlikely but you never know.  More likely is that Middle East conflict could spill into Saudi and even if production isn’t actually affected the threat of that possible disruption would spike Oil.  Or US production could fall dramatically and the re-balance that everyone is saying is 2 years away could happen much faster.

If I could call the bottom for Oil I would obviously wait till the lows and buy my options and wait.  But I certainly don’t have a crystal ball so all I can do is follow my strategy, start under $40 and cost base down till it bottoms.  Its important to be in the right mindset with this strategy.  Lower Oil means a chance to cost base down and increase the upside win since you have a bigger position.  You can’t go all in with this bet, you have leave yourself enough cash to continue to cost base down as it falls.

Final note.  This is a contrarian view.  I read all the articles from all the experts on Oil… storage capacity is running out, Iran is going to flood the market, US dollar is going to go way up, blah blah blah.  This is gambling, I like my reward vs risk ratio so I’m placing my bet 🙂

 

 

I haven’t made many moves in the last Month or so, I’ll provide a quick update, but wanted to share that with WTI below $40 I finally got my window to get long again.

OK, quick summary.

I had a short on the market that I closed yesterday with the big sell off.  Took a 50% loss, but it was a small bet.  I’ve been a little surprised that the market rallied so hard with no big pull backs over the past 60 days.  I do wonder where we go from here, seems to me a little toppy so I don’t think we will have a huge 2nd leg to the rally, but I don’t sense we are way overbought either.   As long as the Fed does a “one and done” message with a really slow ramp on rates I think we will grind up and down overall, and we will move into a longer period where individual stocks will move more independently than they have in the past where everything goes up or down in unison with the market.

I had a long VIX play that is coming up on expiration, we had a spike in volatility a couple weeks back and I took 1/2 off the table when my position over doubled, so I still have some left that I’m looking to close out over the next week or two.  Its the houses money now.  I will continue to look for entries into a 2-month window of long VIX if we fall below 13 or 12.

I still have QCOM, which I had more than a double on, but got greedy and didn’t sell, now I’m sitting on a down 25% position.  Dumb move.  Its way out in Jan 2017 so I have lots of time and they are crawling back up to almost even now based on some recent deals.

I still have 1/2 my Yahoo, I sold 1/2 of my position with a 150% return, lesson learned from QCOM.  I’m actually looking at almost a Triple on the position right now but I want to see what shakes out with this recent board statement that they are exploring options to maybe sell the core and keep the BABA stake.  A little risky perhaps but I could really use a nice 10X return to get back some funds from my eternal refusal to stop betting on VMEM.

VMEM, all positions going to Zero.  Ug.  The stock is now trade at .85cents.  What a joke they are.  The lowest option call is $2.50 so there is no way to play this long or short without just buying the stock.

TWTR, still have a small position of 2017 calls, lots of time on this one, down a bit right now but nothing major, there is a huge spread on the bid and ask so it hard to know what its really worth right now.  I will keep an eye on this and maybe will cost base down one time.

Other than that I just have OIL.

I’m long the USO jan 2017 $15 call.  Its probably going to be a tough 6 months with WTI but I think we will stablize into next year and then start to creep back up to 50-60 range.  If by next fall we are back to 55 or 60 on WTI, this OIL bet will likely 5x return.  Also still have the XLE 2017 calls, same bet, just tracking big oil companies rather than the commodity itself.

My finally note is to highlight that I am going WAY out on expiration dates now.  Outside of VIX and VMEM everything is 2017 dated.  VIX will close this week or next and VMEM is worthless.  If we get a big pullback on OIL in the next couple months I will continue to find money to cost base down.  I’m all in with this bet.  I really believe that $40 is the ‘natural’ bottom for WTI.  Yes it can go way below but I don’t think that it would spend more than a few months below $40, so with 2017 as my window this feel like a solid play.