Short setup in crude oil

Here is a trade setup we published today as a MarketLife TradeLab, available to both MarketLife Premium and MarketLife Plus subscribers.

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After offering trading opportunities on both the long and short side, crude oil rolled over into a downtrend near the end of April 2019.

Recent action suggests a consolidation (bear flag) following a sharp decline. This is the type of pattern that typically sets up further declines.

One possible way to execute is simply to enter short positions in futures or USO on further weakness. Using the boundary of the bear flag as a price trigger is one possibility.

Options on USO also offer an attractive trade: consider the -1 X +3 put (ratio) backspread: buying three of the 21 JUN 12 strike puts for each one of the 13 strike shorted. This trade has no price risk on a rally, and offers very attractive profits on both a moderate downside and “crash” scenario. (A single -1 X +3 profits around $100 if USO declines to $11 and $300 with USO at $10.)

Make sure you understand the risks in an option play like this—a max loss of $100 occurs around 12, and other risks apply, particularly toward expiration. (Assignment risk, for example.)

We would not consider Energy stocks (e.g., XLE, OIH, or individual names such as VLO, XOM, etc.) proxies for this trade—this is a trade in the underlying commodity.

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Adam Grimes has over two decades of experience in the industry as a trader, analyst and system developer. The author of a best-selling trading book, he has traded for his own account, for a top prop firm, and spent several years at the New York Mercantile Exchange. He focuses on the intersection of quantitative analysis and discretionary trading, and has a talent for teaching and helping traders find their own way in the market.