I made a major change with my UCO position this afternoon. I started working on this idea a couple of days ago and wanted to wait until later in the week to kick it off to make sure UCO didn’t rally too soon. Before I made this change today I was short 10 UCO May 13 naked puts (which will be assigned after tomorrow’s close) and was long 10 UCO October 12 puts I’ve been using as a hedge (luckily!) for the naked puts I’ve written in April and May. I planned to keep selling naked puts, but with my option assignment pending I planned to switch to covered calls. I was looking at the call premiums and noticed I might have a better approach by taking on some more risk.
While UCO was trading at $8.76 I sold to close my 10 UCO October 12 puts for $4.10 each and received $4,092.86 after commissions. Originally I bought these October puts for $1,707.14 which gave me a realized gain of $2,385.72. That sounds great on the surface, but my short puts got spanked in the meantime and cost me even more. To deal with that paper loss I’ll eventually have to deal with I decided to continue reducing my cost per share by selling more options. I’m only doing this because UCO has fallen so far already that I think the downside is somewhat limited and with my profit on the long puts my cost is coming down fast.
A little over a minute after I closed my long puts, my limit order on my strangle hit. I sold to open 10 UCO July 7 naked puts and 10 UCO July 12 calls for a net credit of $0.859 for each pair and received $844.72 after commissions. I expected to get the puts for $0.40 each and the calls for $0.45 each and did better on a few of them as they were apparently filled by different buyers. Actually, I tried for a net $0.90 trade at first, but after I closed out my long puts I wanted to get this one in before tomorrow and only had four minutes left in the trading day, so I lowered my limit. The calls are technically naked calls right now, but since my May 13 naked puts are over $3 in the money I have no doubt they’ll be assigned Monday morning. This will turn my naked calls into covered calls.
Here’s my cost breakdown and why I decided to accept the additional risk:
- March 12th – bought to open 10 UCO October puts, paid $1,707.14 (raised my cost per share by $1.71)
- March 12th – sold 10 April naked puts, received $492.86 (lowered my cost per share by $0.49)
- April 16th – sold 10 May puts (in two lots), received $540.86 (lowered my cost per share by $0.54)
- May 20th – sold the October puts I started with, received $4,092.86 (lowered my cost per share by $4.09)
- May 20th – sold option strangle (July 7 puts, July 12 calls), received $844.72 (lowered my cost per share by $0.84)
- May 24th – will buy 1,000 shares of UCO for $13.00, will pay $13,000
That brings my cost down to $8.74 per share. (Oh look, I’m back to break even on paper.) If UCO rallies from here I’ll be forced to sell my 1,000 shares at $12.00 and will pocket $3,264.16 from the series of trades. I don’t think that’ll happen by July expiration though, especially with the dollar gaining strength. I even thought about making my call strike lower, but the difference was only $0.15, so I went for the higher potential return over reducing my cost a little more. If UCO drops below $7.00 and I’m forced to buy another $1,000 shares it will reduce my cost per share even more, down to $7.87 and I’ll have $15,735.84 invested in UCO.
From that point I’ll be writing covered calls on 2,000 shares. In February 2009, UCO made it down to $5.85. I won’t actually be completely shocked if we see it get to that level again, but think UCO doesn’t have more than $2.00 to the downside from here most likely. If I am forced to buy 1,000 more shares I’ll still be able to write out of the money calls for $0.20 or more each month and wait for oil’s recovery. While I wait I’ll continue to reduce my cost per share. I’ll have to see how I judge the market at the time, but if UCO is below $7.00 in July I might even consider selling 20 more naked puts at the $5 strike. It might take months or could take more than a year, but oil will be higher again. It just doesn’t stay down for too long. I didn’t panic on this trade as oil fell and I plan to continue to exercise patience as I wait out this correction.
I was wondering how you were gonna adjust this trade.
My USO trade went pear-shaped too. I closed the long June 37 Calls last week for $1.80 (ish) and am letting the short May 37 Calls expire worthless today. Overall, I’ve a locked in loss on the trade. Oil’s been very volatile lately and I’m going to spend the weekend analysing whether I’d like a new entry into USO.
My UNG trade is looking good. UNG is currently trading at $7.14. If UNG closes below $8 at June expiry, my short Calls will expire worthless and my profit will be $0.1158 per spread for the 50 spreads and I’ll also have the 50 long July 9 Calls for free.
Oil is certainly a weird one lately. I think you’re looking good on UNG. I doubt the euro will gain much more ground on the dollar which should help keep UNG down a bit longer.
Ronan, Weren’t you long USO Oct 37 Calls at $3.05? With 4 months remaining, couldn’t this have been made profitable by selling monthly short Calls? You could have sold the Jul 33 Calls for $1.76 to lower your cost basis from $3.05 to 58 cents. You’d only need to roll to avoid assignment when ITM.
I had been long calls but the problem is that I entered the trade with the opinion that USO (and oil) would trade in a tight range with some upside bias.
This turned out to be wrong and I’d considered adjusting the position rather than close it but, instead, went for closing it and concentrating on my other open positions.
If I were to sell Calls at strikes lower than the 37, I’d reduce my cost basis on the long Calls but it’d be a little on the difficult side to manage the trade because USO would need to rise significantly to make my 37 Calls worthwhile but would need to stay down so that my short calls weren’t excercised.
My position in UNG as well as some trades I made on oil futures should wipe out the loss incurred on the USO trade.
I’m going to be keeping a close eye on USO for a new entry because I think oil (and the Euro) are near a bottom here.
Your adjustments are looking pretty good now… congrats on the trade… Oil had to move higher eventually – and if the BP’s latest attempt at plugging the leak works, we should see a much bigger rise….
(5/28) Thanks Ronan. I’m pretty happy with it right now, but it’s not over until it’s closed. I do think much of the downside risk has decreased. Once I saw oil turn a couple of days ago I considered buying back my July 12 calls, but then decided I won’t mind exiting there if we get that quick of a snap back.
Hi Alex,
I think I remember reading a post or comment about how DO is one of the stocks on your watchlist. What do you think of the following trade I’m eyeing up and have you ever done something with a similar structure?
It’s quite risky but high potential reward (prices are roughly midpoints of the bid/ask as the LEAPS haven’t traded for a while):
Purchase Jan 2012 56.75 Calls: $1,315 each
Sell Jun 2010 58.63 Calls: $295 each
Sell Jul 2010 60 Calls: $365 each
Net Cost of Calls: $655
Pay $35 for a bearish $65 – $60 Put spread together with a Naked $55 Put (July expiry).
Outcome: If DO is below $58.63 for June expiry and below $60 for July expiry, you have Jan 2012 56.75 Call Options for a net cost of $190 each. This is assumming DO remains above $55. However, if DO is below $55 at July expiry, you’d be going long DO at $55 but would receive $5 from your bearish spread.
I’ve been watching this and considering it all morning but got sidetracked at work. I think the shorts will remain in play with a lot of these stocks for the next few weeks and the June Calls should expire worthless. There is a higher risk of a pop before July expiry but, at that point, you’d only be short one batch of call Options.
If this trade worked out perfectly, you’d have the Jan 2012 Call Options in your portfolio for $190 and would have 18 months to write hedged Call Options to further reduce this cost. If DO did increase slowly over the next year, as I suspect it will, you could even write higher strike Calls through that time, reduce the $190, turn it into big profits and still have your ‘free’ Jan 2012 Calls.
Basically, the strategy is designed to take advantage of the hugh volatility in near-term Options which isn’t fully reflected in the LEAPS.
The above trade executed today. The prices weren’t just as good – my basis for the 2012 Calls would be $325 based on the prices obtained. However, I did raise the strikes on the short June Calls to $59.88.
(6/2/10) Interesting move Ronan. Sorry I didn’t get back to you yesterday. That’s more upside risk than I’d like to take, but I could see it working out for you with the near term forces moving against offshore drilling. I probably would’ve waited out the June expiry for safety before writing the July calls, but you’re probably right that the risk isn’t too great offshore will come roaring back yet. When it does, I expect it to rocket higher though.
Agreed Alex. I’m playing this very agressively for the initial 6 weeks – until July expiry. If it works out, I’ll slacken off a bit, i.e. hold the Jan ’12 Calls and sell monthly Call Options for about 1% premium of the chosen strike. With that, I should be able to catch most of the upside over the next 18 months and reduce the cost of my Calls to below $0. It all depends on the next 6 weeks though.