Friday, June 24, 2011

Insurance for Falling Oil Prices

Big news this week was the release of oil from the US, Europe and Asia strategic reserves.  There are plenty of opinions on the merits of this decision.  From a supply/demand perspective the amounts of oil released does not seem that significant, and there are "not too many bullets in this gun" so it hard to see how this changes the long term picture.  Many talking heads on US TV seem to want to make this simply about US politics, but of course they make everything about US politics. 

Full disclosure: I'm not an oil expert.....but of course that does not stop me from having an

IMO I think the oil consuming countries see a few opportunities to change the oil game a little. A few points
  • Apparently, the last OPEC meeting did not end well with the Saudi's and countries like Iran and Venezuela not seeing eye to eye. 
  • The Saudi regime feels as threatened as ever, and much of this threat comes from other Opec countries (mostly Iran) subtly undermining their authority in the Arabian Peninsula
  • The "west" now controls Iraqi/Kuwaiti oil and is likely to control Libian oil soon.  
  • Brazil is having success in offshore drilling, and Canada the US are getting some oil from shale. 
  • China is buying up, and and taking control of African oil reserves.
  • Natural Gas is being pushed as an alternative to oil (even in transportation) by many parties in the US.
All these points could mean that now is the time where the oil consuming countries and the Saudi's can have the power and mutual incentive to ban together and "break the back" the rest  of the Opec cartel. 

Further, many governments perceive that some larger financial players have figured out how to "game" the oil markets (shocking I know).  I suspect many governments would not be too upset if some of these players got burned by a change in the world oil game.  Lastly, the world economy would benefit from a drop in the price of oil and that would help the popularity of politicians across the globe.

Trading Strategies

There are a lot of opinions, assumptions and theories in that long preamble with which a reader can agree/ disagree and like/dislike.  However, CCI feels that major governments may have set out to drive the price of oil down in the short term.  The release of oil reserves might just be one step in that process.   Generally, CCI's full portfolio is overweight energy and wants to remain that way in the longer term.  However, in the shorter term, CCI does not want to fight this potential trend and is looking for ways to short the energy markets.

Over the past two days, CCI day traded the double short energy etf  (DUG)
 There was plenty of volatility which meant there were chances to make money in this trade, but disappointingly  CCI only managed to break even on these trades.   So for the year, CCI is 5-0-2 trading the double shorts.

I wanted to close out the position in DUG before the weekend  (mostly because of the weird way these double short etfs are structured), but wanted to have some hedge against falling oil prices for the weekend.  Hence CCI just bought a lots worth of  July $35 puts in the oil etf (USO) at the end of the day as a straight insurance policy against falling oil prices. 

Stay tuned to see if this was a good insurance policy to write, and if other vehicles to short the energy space might be deployed next week.

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