"Black Gold" Bulls are Seeing "Red"!
Fundamentals
Oil bulls are certainly having a rough month of May so far, as the soon-to-be lead July contract has fallen over $17 per barrel since May 1st. The continued lack of confidence by traders for a legitimate solution to the rising debt crisis in Europe has sparked a move away from so called "risky" trades and into the perceived "safety" of the U.S. Dollar, Treasuries, and Gold. Long Crude Oil was a favorite trade of speculative accounts for months, as traders bought oil futures in anticipation of a global economic recovery, which in turn was expected to improve oil demand, especially from Asia and the U.S. However, the fears that the EU quagmire could spread outside of the "continent" and put the brakes on the recovery have been put in the spotlight, leading to a harsh liquidation of long commodity positions, including Crude Oil. Also sending a negative tone to NYMEX WTI oil futures has been the surge of oil inventories in Cushing, Oklahoma, the delivery point for the NYMEX futures contract. Inventories at Cushing have gone to record levels, causing near-by futures to trade at a huge discount to more deferred contract months. The soon-to-be-expired June futures even briefly traded below $70 per barrel on Monday, before rebounding above this key psychological level at the close. However, some traders believe that the option expiration for the June futures options may have been behind the fall below $70, as those holding short puts at the $70 strike were forced to sell additional futures contracts to hedge their positions. Barring any additional news out of Europe, Oil traders will turn their focus to the weekly Energy Information Administration (EIA) energy stocks report. Pre-report estimates are for U.S. oil inventories to have risen by 800,000 barrels last week, as refinery operation rates are expected to have fallen by 0.3% last week. What will be interesting to watch for in the EIA report is the levels of oil and gasoline imports last week, to see if any economic slowdown in Europe will translate into additional fuel being sent from Europe to the U.S. If so, we may see U.S. refining rates continue fall, which could cause near-term oil futures to continue to tumble faster than the deferred months, as the "market" bids for storage.
Trading Ideas
After the steep sell-off seen in oil futures this month, some technical indicators, including the 14-day RSI, are showing that the market may have become oversold. In addition, the July oil futures are now running near several key support points at 71.65, 70.00, and even near the 65.00 area. Some traders expecting a rebound in oil prices -- or at least to see these key support points hold -- could look into selling puts in oil futures options. An example of this trade would be selling the July oil 63 puts. With July Crude trading at 74.13 as of this writing, these puts could be sold for about 0.47 points, or $470 per contract, not including commissions. The premium received is the maximum potential profit on the trade and would be realized if July crude Oil is trading above 63.00 at option expiration in June. Given the risk involved in selling naked puts, traders should have an exit strategy in place in the event the trade moves against them. An example of an exit plan would be to close out the position before expiration should July Oil close below major support at 65.00.
Technicals
Looking at the daily chart for July oil, we notice how sharply oil prices fell, especially once the 50-day moving average was taken out on the downside. Prices briefly attempted to consolidate around the 200-day moving average, but also succumbed to a sharp round of long liquidation selling tied to the fall of the Euro currency vs. the U.S. Dollar. Before the sell-off begins, we should give some notice to the bearish divergence that formed starting at the April highs, in which this momentum indicator failed to make a new high reading as the July contract moved towards $90.00 per barrel. Currently, the 14-day RSI has moved into oversold territory, with a current reading of 28.51. The February lows of 71.65 look to be the next support point for July oil, with resistance seen at the 200-day moving average currently just above the 80.00 level.
Mike Zarembski, Senior Commodity Analyst
