[Duende]

So, I'm sure many of you've seen that the economy tanked again today, along with the price of oil. It's under $50 again!

I have read elsewhere on the board about options trading in oil. The premise, as well as I can understand it, is that if I were to invest a sum of money now - say, around $3,700 - then I could 'control' around 75 of barrels of oil. Let's say then that oil goes up to $150 next summer. I could then sell my option of 75 barrels of oil for $150 each, coming away with around $11,250, minus fees, etc.

However, if oil falls further - let's say to $20 per barrel - then, by the end of the option timeline, I'd have to sell it for that price: 75 barrels at $20 each = $1,500, for a total loss of around $2,200.

Is there anything I'm missing or have wrong? Also, where could I look to find information on doing this? Thanks.

[davep]

So, I'm sure many of you've seen that the economy tanked again today, along with the price of oil. It's under $50 again!

I have read elsewhere on the board about options trading in oil. The premise, as well as I can understand it, is that if I were to invest a sum of money now - say, around $3,700 - then I could 'control' around 75 of barrels of oil. Let's say then that oil goes up to $150 next summer. I could then sell my option of 75 barrels of oil for $150 each, coming away with around $11,250, minus fees, etc.

However, if oil falls further - let's say to $20 per barrel - then, by the end of the option timeline, I'd have to sell it for that price: 75 barrels at $20 each = $1,500, for a total loss of around $2,200.

Is there anything I'm missing or have wrong? Also, where could I look to find information on doing this? Thanks.

If you're into trading oil options, your minimum bet is 1000 barrels.

With 3700 dollars you could 'control' 1000 barrels at 150/barrel (or possibly 140 at the moment) for five years hence. Once you're in the money and with enough time left on the option, you could sell (or wait a bit and see if you can further leverage your investment). Imagine if you sold at 200 dollars. You would make 50k dollars plus the time element of the option.

However, you have to be aware of the fact that you could lose all your investment. Oil could stay low for a long time (but I have great difficulty in imagining it being low for five years, given potential dollar decreases on foreign exchanges, and subsequent inflation).

There are many articles on options trading for commodities. This is a good start

[Duende]

davep wrote:

If you're into trading oil options, your minimum bet is 1000 barrels.

With 3700 dollars you could 'control' 1000 barrels at 150/barrel (or possibly 140 at the moment) for five years hence.

Thanks for the info. But why could I only 'control' 1000 barrels at $150/barrel when oil is currently under $50? I would think I would be able to 'control' three times as much. Please explain. Thanks!

[davep]

davep wrote:

If you're into trading oil options, your minimum bet is 1000 barrels.

With 3700 dollars you could 'control' 1000 barrels at 150/barrel (or possibly 140 at the moment) for five years hence.

Thanks for the info. But why could I only 'control' 1000 barrels at $150/barrel when oil is currently under $50? I would think I would be able to 'control' three times as much. Please explain. Thanks!

You decide a price and a date. There is a cost for the option at that price, depending on current price, inflation, volatility and time until the option expires.

Options are sold in units of 1000 barrels. Read the information I posted.

[Duende]

davep wrote:

With 3700 dollars you could 'control' 1000 barrels at 150/barrel (or possibly 140 at the moment) for five years hence.

Ahhh... I posted too soon. Ok, I think I get it now: it's about how much you think it will sell for by a given date. So, where do I look to see how much it would cost to sell later at, let's say, $100? Is there a chart or something?

Also, I am aware that I could lose all my money. But is it possible to end up owing more than your original investment?

[smallpoxgirl]

Lets back up a couple of steps.

There's a couple of ways to invest in oil.

The most direct and most traditional is futures. Futures behave a lot like what you described. You buy a futures contract and place down some margin. If the price goes up, the value of your contract goes up. If the price goes down the value of your contract goes down. If it goes down below you margin requirement, then you're required to front more money. The biggest problem with trading futures is that the smallest futures contract is 500 barrels. For a lot of people, that's more risk than they can/should take.

The other vehicle that you can reasonably use to invest in oil, is ETF shares. USO is an ETF that invests strictly in oil futures. One share of USO has about the same leverage as 0.8 barrels of oil. For smaller traders it can be a much more reasonable way of tracking oil. The most prominent down side with USO is that ETF's trade during market hours, typically 8:00 am to 6pm eastern if you include the electronic after-market trading. Because the futures trade around the clock, you expose yourself to the possibility of things moving adversely against you in the middle of the night when you can't close your position. The other down side to investing in USO is that you're not getting nearly as much leverage as you would with futures.

Options are a separate thing that can be traded on either futures or ETF shares. When you buy a call option contract on USO shares, you are buying the right to buy shares of USO, by a certain date, at a pre-arranged price. If the price of oil (and USO) goes up, you can excercise your option and get shares of USO on the cheap, or you can just turn around and sell your option and pocket the profit. If the price goes down, you can just let the option expire and lose your purchase price, or you can sell the option before that happens and try to recoup part of your loss. Options trading is really complicated. I'd highly advise doing a bunch of reading, and paper trading with them for a while before jumping in. I was trading USO options for a while. It worked ok, but I ended up deciding that I was devoting far too many brain cells to trying to figure out which option to buy and I am far better off devoting that energy to analyzing the market and trying to decide when to get in and when to get out.

[davep]

davep wrote:

With 3700 dollars you could 'control' 1000 barrels at 150/barrel (or possibly 140 at the moment) for five years hence.

Ahhh... I posted too soon. Ok, I think I get it now: it's about how much you think it will sell for by a given date. So, where do I look to see how much it would cost to sell later at, let's say, $100? Is there a chart or something?

Also, I am aware that I could lose all my money. But is it possible to end up owing more than your original investment?

Go to Nymex.com, click on the little rig thing on the left (under where it says 'energy') and click the 'Options' tab.

Then click on 'american style options'. Next you have to agree to their 'Viewing and Usage' terms. Do so.

On the following screen, click 'View All Calls'.

Then select the date you want (e.g. December 2013, IIRC, after a few years, options are only available in June and December) and click 'go'

You will see the latest prices for calls at the prices listed in the left-hand column. Note that the left hand colum is equivalent to the price per barrel in cents (e.g. 15000 for 150 dollars).

The seventh column gives the latest settled option price for the selected price point at the selected dste in the future.

I know it's difficult at first, but take your time and absorb the concepts. The thing I found difficult was the concept of future volatility, in other words forget all the crap about time, inflation etc, the option is worth what it's worth depending on current sentiment (not some pre-ordained formula), so in a falling market when the hedge funds are shitting themselves and trying to de-leverage, option prices will fall more than is rational.

[Duende]

Thanks smallpoxgirl. Very thorough explanation.

smallpoxgirl wrote:

One share of USO has about the same leverage as 0.8 barrels of oil.

Ok. Is USO/ETF similar to options, where you have a minimum purchase amount?

Got any good links, cautionary tales or recommendations?

Thanks to all, great info.

[Duende]

davep wrote:

...so in a falling market when the hedge funds are shitting themselves and trying to de-leverage, option prices will fall more than is rational.

So, that's why it's a good idea to buy now, if I'm to understand correctly, right?

[davep]

davep wrote:

...so in a falling market when the hedge funds are shitting themselves and trying to de-leverage, option prices will fall more than is rational.

So, that's why it's a good idea to buy now, if I'm to understand correctly, right?

Unless it goes down to 10 dollars

[smallpoxgirl]

Ok. Is USO/ETF similar to options, where you have a minimum purchase amount?

USO you buy by the share. 1 share is about 0.8-0.9 barrels of oil. You can buy 1 share if you really want.
Futures you buy per contract. 1 contract=500-1000 barrels depending on the specific contract.
Futures option, the minimum is 1 contract =1000 barrels.
For USO (and other equity options) 1 contract = 100 shares.

The relationship between price movement of the option contract and price movement of the underlying asset is complicated though. If USO goes up $1, that doesn't mean your option contract will go up $100. There's a number called delta that quantifies this relationship. If you're interested in learning more about options, I'd start with the Chicago Board of Options Exchange link. They have a number of good (and free) online classes. CBOE will teach you about equity options (i.e. stock and ETF options). Futures options are somewhat different, but the basics are the same.

[smallpoxgirl]

davep wrote:

...so in a falling market when the hedge funds are shitting themselves and trying to de-leverage, option prices will fall more than is rational.

So, that's why it's a good idea to buy now, if I'm to understand correctly, right?

I would very wary about buying options right now. One of the things about options is that when markets are moving around erratically, for any given option there is a greater chance that it will become valuable at some point in the future. Because of this, there will tend to more people wanting to buy options, less people wanting to sell options, and the prices go up. This is quantified as a number called implied volatility. CBOE maintains an index that reflects how high or low implied volatilities are at any given time. The ticker for it is VIX. Suffice to say that the VIX has been at record high levels for a couple of months now. This means that for any given option the prices are comparatively high right now and the price of those options will likely fall in the future once the markets calm down and the implied volatility falls.

[mkwin]

davep wrote:

...so in a falling market when the hedge funds are shitting themselves and trying to de-leverage, option prices will fall more than is rational.

So, that's why it's a good idea to buy now, if I'm to understand correctly, right?

You are slightly confused about options.

An option is an option to a buy an oil futures contract at a specified date and for a specified price. If oil is higher at this specified point you make $1000 for every $1 oil is higher than your specified price (known as the call price) per contract.

The only thing you risk with options, and this is the main benefit, is the intital cost of buying the option. The price of an option depends on the the Futures contract price for the date you want the buy the option on.

For example, a $100 CALL option for December 2012 was trading at $8000 last night. If you bought this option and the price of oil in December 2012 was $90 your contract would expire worthless and your $8000 would be lost. If, however, oil was at $150 your contract would be worth $50,000, if it was $200 then it would be worth $100,000. You don't have to wait for the contract to expire either, options are in an actively traded market so you call sell at any time for the market price.

[Duende]

mkwin wrote:

You are slightly confused about options.

Understatement of the year.

Thanks for all the the info, all. Very illuminating for me.

smallpoxgirl wrote:

I would very wary about buying options right now.

If I wait until the VIX settles down a bit, don't I risk the chance that the oil price per barrel will have risen (presumably with the market)? Or, is it possible that the VIX will settle down at the same time the market remains down?

[smallpoxgirl]

If I wait until the VIX settles down a bit, don't I risk the chance that the oil price per barrel will have risen (presumably with the market)? Or, is it possible that the VIX will settle down at the same time the market remains down?

Yes. You run that risk. If you buy an option when the implied volatility is super high, you run the risk that the underlying goes up in price, but the value of your option goes down because the IV dropped faster. The VIX is just a general guide for the overall options markets. You need to find graphs of the IV of the option you're thinking about buying and decide how high it is and what it's likely to do. This is the kind of thing that makes options trading so complicated. You also have to calculate out the various strike prices and expiration time periods and decide which is going to give you the best return. Deciding that oil is down and will probably go back up is step 1 in about a 10 step process with buying options. Like I said, you really need to spend a while learning about them before wandering into that marsh. Before you think about buying them, you need to understand all the different dynamics and how they work together.

[vision-master]

So, I'm sure many of you've seen that the economy tanked again today, along with the price of oil. It's under $50 again!

I have read elsewhere on the board about options trading in oil. The premise, as well as I can understand it, is that if I were to invest a sum of money now - say, around $3,700 - then I could 'control' around 75 of barrels of oil. Let's say then that oil goes up to $150 next summer. I could then sell my option of 75 barrels of oil for $150 each, coming away with around $11,250, minus fees, etc.

However, if oil falls further - let's say to $20 per barrel - then, by the end of the option timeline, I'd have to sell it for that price: 75 barrels at $20 each = $1,500, for a total loss of around $2,200.

Is there anything I'm missing or have wrong? Also, where could I look to find information on doing this? Thanks.

Why not invest in a substainable future instead?

[Duende]

vision-master wrote:

Why not invest in a substainable future instead?

Check. I tend to think of that sort of 'investment' as being a kind of intangible psychological one.

The day the bottom falls out, I'll be ready. I guess until that day comes I need somewhere to put this little bit of cash that's burning a hole in my pocket. And I know sure as hell that cash itself will not be the place to be.

[CrudeAwakening]

Don't forget, in buying long-dated options, you're also betting on the continued existence of the oil exchange. Probably (?) a safe bet, but who knows what may happen in the future.

If you think oil is heading to Simmons territory, and the dollar is heading for a fall, buying call options on futures seems a relatively straightforward way of hedging against these things. All you can lose is your premium (plus commissions). But I think you should go into it with the expectation that you will probably lose your money, not that "PO will make me rich".

Also, with options on futures, if you choose to exercise your option, it means taking a position in the futures market. Not so nervewracking if you exercise close to expiry, but you will be subject to margin calls etc until you are able to offset your futures contract.

There is an oil volatility index called the OVX, which is a counterpart of the VIX. As I understand it, while the VIX is negatively correlated to the S&P, the OVX seems to have been increasing regardless of oil prices.

[Duende]

CrudeAwakening wrote:

But I think you should go into it with the expectation that you will probably lose your money, not that "PO will make me rich".

Exactly - I totally agree.

CrudeAwakening wrote:

Also, with options on futures, if you choose to exercise your option, it means taking a position in the futures market. Not so nervewracking if you exercise close to expiry, but you will be subject to margin calls etc until you are able to offset your futures contract.

This part is sort of lost on me. Can you explain a little further about margin calls?

[davep]

This part is sort of lost on me. Can you explain a little further about margin calls?

Just sell your options before they expire, it's the only way for us simpletons to do it.

BTW, does anybody have a link to a crude options implied volatility chart?