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The stock market's soap opera star this summer has certainly been crude oil. Even the presidential candidates are making crude oil a topic for their campaign trail. Obama wants to remove oil speculators out of the market to let crude prices settle, while John McCain has countered by saying that the amount of oil produced must be increased via production methods at home. While the politics of oil still need to be worked out, there is much we can do to understand and hopefully predict the future movements in oil prices.
The temporary $9 drop in oil prices
On July 7-8, the oil market tumbled by $9, as a tribute to a new high that was reached just the week before at $146 a barrel. USO, the ETF that tracks the price of oil, has been on a strong upward trend since March, where it broke out from the $80 level and has since advanced to $110. The relative strength of oil prices has been fading since March, proving that the amount of money left in this bull run might finally be coming to an end. Without fresh money in this rather weak oil movement, there is a chance that the market could turn the tables and see a huge correction within just a few short days.
The $150 barrel prediction
The $150 prediction by a Goldmann Sachs analyst surely worked to pump up the price of oil; in fact, on July 11th, oil set a record high at $147 per barrel. This prediction added a goal for the price, but also set a new take profit for many traders who were planning to dump at the then current price in the $130s. If anything, the prediction did not set much guidance as much as it set where traders would eventually sell, which would be around $150 per barrel. At a high price like this, it should be understood that many traders are seeing hefty profits; a dip would be proof that profit taking is occurring, whether that happens overnight or over a large breakdown.
How oil will move
Just last month, it was reported that the amount of shorters actually outnumbered buyers, and there is hope that momentum will further drop and bring lower prices. Without any geopolitical news, the price of oil should slowly ebb to a comfortable position in the $120s. At that point, it is up to traders whether they want to play a dead cat bounce back to the $130s or sell off to the $100 level. At this point, $110 per barrel seems to be the support line that everyone is looking for. It took days to break $110, and even then, there was plenty of resistance to its movement.
Plan B for charting movements
With a renewed number of short sellers, the dangers of a rising market grow again. If there is more geopolitical news, especially that out of Israel or Iran, the chance of rising oil prices is near perfect. Shorters will be forced to buy to cover, causing an even greater buying spree. A short squeeze is very dangerous near a market top because it can completely eliminate any idea of a price ceiling. Traders that were willing to sell at $150 per barrel might grow reluctant if news breaks out in the Middle East. This is what makes oil so hard to trade; there is no charting its course outside of what is heard on the news lines. Much of the rally to $147 was created on Mid East tensions stemming from Iran’s missile test.
How to trade oil in this market
Trading the tumultuous oil roller coaster can be difficult, but the best position is in options, either future options or via an ETF that offers option trading. For USO, the $110 put options (current price of the ETF is $110) cost just over $6 each. This price is very cheap considering the limited downside that you suffer if the price goes against you. Looking just one month out to August, there is still plenty of time for oil to drop, or for it to continue the rebound. Luckily with options, you will just be out $6 per share, regardless of how wildly the market moves. This is what I like about options – giving you an ability to more faithfully trade the wild commodities market.