A Cheaper Way to Buy Cheap Oil

I don’t care about fundamental analysis.
Yes, I want to participate in owning solid sectors, industries and various countries, but when it comes to archaic fundamental measures like price-earnings ratios or the like I just don’t care.
I care about returns. I don’t care how I get there; I only care about the sum at the end. The rest is just noise.
Take oil for instance, as seen through the United States Oil Fund (NYSEArca: USO).
The ETF is down roughly 75%-80% since its highs in mid-2014. Now remember, this is oil we are talking about. Like any other asset, it is exposed to market turmoil and risk, but the commodity isn’t going to zero.
I’m a contrarian at heart. My options trading is centered on taking advantage of short-term extremes in the market as seen through mean reversion. Most of my loyal readers know this already. But, what I don’t talk about very often is that my strong contrarian views carry over to stocks as well.
Marketing would have you believe I hate stocks, but that’s ludicrous. I don’t hate stocks. I love stocks. I use various options strategies like covered calls and selling puts that capitalize on stocks. So again, it’s silly to think any investor hates stocks.
What I do hate is the capital requirement that it takes to own certain stocks. I know I can use my capital more wisely using various options strategies that carry the same risks as holding the stock outright – but require far less capital. But I will save that discussion for another time.

An Opportunity in Oil

As an investor, I love opportunities.
I typically have a large percentage of my overall portfolio in cash to take advantage of what I feel are “real” opportunities.
Yes, as an investor, I’m exposed to major benchmark ETFs. I feel if you have to expose yourself to the market on an ongoing basis, major benchmark exchange-traded funds like the SPDR S&P 500 ETF (NYSEArca: SPY), PowerShares QQQ (NASDAQ: QQQ), iShares Russell 2000 ETF (NYSEArca: IWM), SPDR Dow Jones Industrial Average ETF (NYSEArca: DIA) and a few sector ETFs are the only responsible way to engage.
Academia has proven time and time again that all other methods have proven to be inferior over the long term. Also, as many of you already know, a large portion of my portfolio is mainly focused on a high-probability approach using a variety of options selling strategies.
But as I said before, I like to have a decent amount of cash sitting on the sidelines at all times, patiently waiting for contrarian-based opportunities. We’re seeing one those contrarian opportunities right now to buy cheap oil.
Just look at the research from esteemed analyst Mebane Faber and try to tell me the pot odds over the long term (and he only uses three years) don’t side with the contrarian investor:

For some, it’s hard to buy something down 80%. But when you look at the returns going forward, why would you not take a chance? We all want to buy something on sale.
Well, when something that is a necessity for societies around the world to function is 80% off and at historic lows, why would I not want to buy it? Especially if I have a long-term view on the asset. And when I say long-term I mean anywhere from three to 10 years, if not longer.
So what’s the play?
I’m selling puts.
Selling a put obligates you to buy shares of a stock or ETF at your chosen short strike if the put option is assigned.
For example, let’s say you wanted to buy the United States Oil Fund, but not at the recent price of $9.70. You prefer to pay 12.3% less, or $8.50.

By selling the March 8.5 puts you can bring in approximately $0.38 in premium, or $38 per contract. In this instance, you are selling the put with the intent of buying the ETF for $8.50 – if, at expiration in roughly 50 days, the stock is trading at or below $8.50.

Selling the 8.5 put requires you to have $850 of cash in your trading account.
Typically, selling puts only requires 20% of the $850, or $170, but retirement accounts and certain brokers require the puts to be cash secured. And in this case, that would be the $850. The return on the trade is 4.4% over roughly 50 days and over 32% annually. And if the puts were not cash secured, the return would be significantly higher.
If the ETF closes at March expiration above $8.50, we keep the $38 and oftentimes repeat the process by selling more puts – perhaps at the 8.5 strike or possibly at a different strike price. It truly depends on where the stock is trading at the time we sell the puts and how much premium we wish to bring in.
If the ETF trades for less than $8.50 at March expiration we are assigned shares for $850 per put contract sold. Remember that one contract equals 100 shares of stock.
Oftentimes when this occurs I will begin to sell covered calls on the ETF so there is an ongoing source of income coming in. I take this approach in one of my High Yield Trader portfolios, appropriately named the Income Cycle Portfolio.
USO is actually one the positions in the Income Cycle Portfolio. My upcoming webinar on Thursday will help you to further understand how I trade ETFs like USO – and more importantly, what each trade alert covers. For it is the process, not necessarily the trade, that is important.