Traders Scramble to Bet on Crude's Bottom

The eventual rebound in crude prices may not match the recent sell-off in velocity or magnitude

by Bernie Schaeffer

Published on Dec 4, 2018 at 8:42 AM

The fourth-quarter sell-off in oil prices has been fairly massive in magnitude, with the West Texas crude-tracking United States Oil Fund (USO) down about 34% from its Oct. 3 intraday peak of $16.24. The commodity fund's collapse occurred with such blinding speed that its 50-day and 200-day moving averages are only now, as of Friday's close, on the verge of completing a "death cross" in confirmation of this bearish momentum. Meanwhile, its 14-day Relative Strength Index (RSI) spent the entire month of November lodged below the 30 level that denotes "oversold" territory -- its longest such consecutive stretch in years.

The "large speculators" group tracked in the weekly Commitments of Traders (CoT) reports appears to have been preparing for this sudden bear market in oil for quite some time now. These investors have been sharply paring their exposure to crude since the start of July, and as of the Nov. 27 reporting date, were holding their smallest net long position on oil futures in 17 months.

But elsewhere, the freefall in oil prices has sparked an almost directly inverse spike in option open interest on USO, most particularly on the call side of the equation. As of Friday, call open interest stood at a new 52-week high of 2.64 million contracts, while put open interest stood at a formidable peak of its own -- 1.90 million contracts, in the 99th percentile of its annual range.

At least some of this call activity has been buyer-driven, per data from the major options exchanges. In the past 10 days alone, USO has garnered a call/put volume ratio of 2.35 across the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) -- indicating that traders have bought to open more than twice as many bullish bets as bearish over the past two weeks. This ratio of calls to puts ranks higher than 85% of other daily readings over the past 52 weeks, even as USO hit a new low on the charts to end the week.

A review of the recent fund flows activity in USO stirs up still more imagery of oil investors reaching for falling knives. From Oct. 1 through Nov. 29 -- a period of time overlapping almost precisely with the aforementioned one-third haircut in the fund's share price -- etf.com data shows net inflows of $407.13 million for USO. But this "wrong way" fund flow activity is nothing new for USO players; the exchange-traded fund's (ETF) year-to-date rally of 29.2% through the end of September was accompanied by net outflows of $766.43 million.

The price action in USO has been primarily horizontal over the last week, as the shares consolidated between $10.50 and $11.10 following a substantial bear gap on Nov. 23. The recent lows roughly coincide with the October 2017 highs, which appear to be providing some measure of support at the moment. This tentative testing of an apparent bottom for oil -- combined with recent speculation of a possible Saudi production cut, and perhaps even the "too far, too fast" nature of the sell-off itself -- may have helped to inspire the recent influx of call-buying and USO inflows.

But despite the severity of its sell-off over the past two months, traders should note that USO has room to keep retreating before revisiting its 2017 lows south of the $9 level, not to mention its early 2016 trough around $8 per share. And even if further downside is limited from here, that won't necessarily translate into an equally fast and furious rally -- particularly with sentiment already so wildly bullish on the collapsing commodity fund.

uso open interest 1130


Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, December 2.

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