First, any conflict with a Middle Eastern country makes traders nervous and the knee-jerk reaction is to buy oil. This crisis is just heating up. Second, hedge funds love to trade oil as a proxy for better economic growth and Q2 growth in the U.S. has just come in hot.
Here’s an inexpensive way to play rising oil prices. The United States Oil ETF (NYSEARCA:USO) has broken out of a nice consolidation pattern. If the middle east continues to hold the focus of markets, oil prices could continue to march higher in the next couple of weeks.
One way to play it, would be a “bull call spread” on USO. This might sound confusing but its actually very simple. First it expresses a bullish view. The “spread” while lowering your profit potential, also lowers the cost of putting the position on, which is a nice feature in a market is volatile as oil.
Here’s an example: You could buy an October $40 call option on the United States Oil ETF (USO) which will cost you approximately $.95 cents — and sell a United States Oil ETF (USO) October $42 call option for 50 cents. The total option position costs only 45 cents. Your maximum profit is $1.55. The maximum profit is the difference between the two strike prices $42 -$40, minus an outlay of 45 cents for the spread. Your potential profit on this option position is 340% if the spread works out.
To sum up: For every $45 dollars this option would return $155 in a best case scenario. Your worst case scenario is you lose your premium ($45).
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William Meade is the President of Pure Alpha Research, a hedge fund consulting and investment research firm. He is the former Director of Research at Zacks Investment Research in Chicago. Before that, he was the lead analyst at a top performing $1.2 Billion dollar institutional investment firm and hedge fund. Mr. Meade has a Masters in Applied Economics from The Johns Hopkins University. Learn more about William Meade and how he follows Billionaire Investors into stocks by visiting the Billionaires Portfolio.