Oil prices slipped under $50 on Thursday and investors are now starting to think the oil bull has now decided to graze for a while. If oil goes lower, that likely means a stronger dollar and lower prices for a number of emerging markets. For investors looking to time entry into commodity markets, including oil and its derivatives, the options market is a clue as to where oil futures are going.
Crude oil prices over $45 brings a number of shale oil drillers into the market. The rig count has been rising for several weeks now. This is an indicator watched by oil traders.
The more rigs there are out there drilling, the greater the amount of future oil supply there is in the market. “It is very important that you position yourself carefully and as long as the price stays above the level of $50, any upside trade should be taken cautiously,” says Naeem Aslam, chief market analyst with ThinkMarkets in London. Aslam correctly called the Brexit vote last year when polls were all indicating otherwise. Aslam tells commodity investors that OPEC can only do so much when it comes to global oil supply and price drivers. If shale oil producers keep pumping, there is nothing Saudi Arabia and Russia can do to short of reducing their own pay rate. While Aslam does not say the Sauds and Russians will give up on their deal to curb production, if American firms keep a cap on oil, then the two countries could give up on the deal made late last year and start producing more oil again in an effort to squeeze shale companies here. Oil, in other words, may very well have a ceiling.
Earlier this year, in fact, Barclays Capital forecast oil prices topping out at around $62 per barrel by the summer before falling to the $50s again. We are now below the $50s.
“The only scenario which we can think of that can help the oil market is a demand shock, and it is not something which is going to make an impact overnight,” says Aslam. He notes that Trump’s $1 trillion infrastructure plan is going to help the demand equation when it comes to energy sector, but an infrastructure bill hasn’t been signed and is currently third on the agenda after the Affordable Care Act revise and corporate tax cuts, both signature issues for this Administration.
The ProShares Ultra DJ-UBS Crude (UCO 29,55 -0,25 -0,82%) fund, one of the largest, leveraged ETF day trades, shows that open interest favors call options. The volume for call options is also substantially higher, Aslam says. As of Thursday morning, the volume is 12, 190 when the 5 day average volume is 6,768.
Oil’s price trend line since the most recent lows felt in August 2016 show price support of $45.10. “If we break this trend line, then we could see the current sell-off becoming worse,” Aslam says.