Two Reasons to Buy Oil

Posted on November 11, 2011 by

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I’m entering a position in oil. Here’s why:

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Reason 1: Economic outlook

Oil goes up when the economy is good because energy literally fuels our economy.  There are a number of signs things are looking up.  We’ve been plagued lately by Greece and Italy.  Greece has responded by bringing on a new MIT grad prime minister, and Italy is moving Berlusconi out of the way.  These are both good signs.  In the US we’re seeing a reduction in unemployment, and positive consumer sentiment.

Reason 2: Israel may strike Iran

“Israel will launch military action to prevent Iran developing a nuclear weapon as soon as Christmas, intelligence chiefs have warned.” — Daily Mail

“The possibility of a military attack against Iran is now closer to being applied than the application of a diplomatic option” — Shimon Peres

This is strongly speculative play, so don’t invest in oil only on this basis.  However, if Israel were to strike Iran, I believe oil would would surge.  Iran is the world’s 5th largest supplier (after Saudia Arabia, Russia, the USA, and China).  I don’t think this affect would last long though, because Israel would likely not strike Iran’s oil producing infrastructure.

Would Israel really attack Iran?  Probably not.  There are indications that these noises from Israel are saber rattling aimed at convincing the rest of the world to step up economic pressures on Iran.

How to make this play

There are a few ways to approach it. A story at seekingalpha.com recommends going long on a 3x energy ETF and short the SP500 via a 3x short ETF.  I agree with many points in that article, but I think the approach is risky and extreme.

Here’s what I’m going to do: First, buy oil.  One way to do this is via the ETF OIL. OIL is presently priced at about $25.00.  Next, look for a way to hedge this. Ordinarily I would buy a good airline like Delta (DAL).  I’m not going to buy Delta today though, because it’s up nearly 4%.  I’m going to look for a dip in the next few days to enter this hedged position.

Another possibility, once you hold OIL, is to sell covered calls.  The November 25 Calls are priced at $.55, which provides 1.4% return in only one week.

Exit…

OIL closed above the strike price on expiration so this trade ended profitably.

Disclosure: Tucker Balch is long OIL and DAL.

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