Where Did All the Oil Go?
Friday, December 23, 2011
The upward bias in Oil prices has favored bullish trading strategies the past several months. Strong support in February Crude is seen at 90.00, and traders looking for this support point to hold may perhaps wish to explore selling puts in Crude Oil futures options with strike prices below support at 90.00. For example, with February Crude Oil trading at 98.75 as of this writing, the February 85.00 puts could be sold for 0.37, or $370 per option, not including commissions. The premium received would be the maximum potential gain on the trade, which would be realized at option expiration in mid-January should February Crude be trading above 85.00. Given the risk involved in selling naked options, traders should have an exit strategy in place should the position move against them. An example of such a strategy would be to buy back the short option prior to expiration should the option premium trade at 2 ½ times the premium received for initially selling the option.
Fundamentals
Oil futures seemed poised to test the $100 per barrel level once again, as a huge draw in Oil inventories last week sparked renewed buying. On Wednesday, the Energy Information Administration reported that U.S. Crude inventories fell by 10.6 million barrels last week, which is more than four times the pre-report estimate. Large declines in Oil inventories at the end of the year are not uncommon, as refineries attempt to minimize inventories for tax purposes. However, the size of the decline was a surprise, with the majority of the decline seen in the Gulf Coast and West Coast regions. The closing of the Houston Ship Canal last week may account for some of the declines in the Gulf Coast region, as well as sharply lower Crude Oil imports last week. Many traders will be monitoring the weekly reports in the coming weeks, to see if Oil inventories built sharply in January. If they did, this would confirm the December drawdown was mostly tax related. In addition to lower U.S. Crude inventories, geo-political risks also have been supporting Oil prices, with potential sanctions on Iran looming due to its nuclear ambitions, as well as political unrest in Egypt and now Iraq. The European debt crisis has been a weight on Oil prices this year, as a major economic slowdown on the "Continent "could spread beyond Europe and lead to an overall weakness in global energy demand. However, emerging markets still have a thirst for Oil, and even countries such as China, where economic growth levels have subsided, are still expected to show increased demand for Oil and fuel products in the coming year.
Technical Notes
Looking at the daily chart for February Crude Oil, we notice prices rebounding after briefly trading below the 200-day moving average. Since the recent highs were made back in mid-November, prices have formed what appears to be a "bull flag" formation, which is generally viewed as a consolidation formation that typically resolves itself in the direction of the previous major trend. Volume has also been on the lighter side during the past few weeks, which is consistent with a "bull flag" formation. The 14-day RSI has turned up, with a current reading of 54.65. The December 16th low of 92.52 is seen as near-term support for February Oil, with resistance seen at the November 17th high of 103.37.
Mike Zarembski, Senior Commodity Analyst
