Oil Options Strategy: 1x2 Call Ratio Spread Explained

Key Concepts

• IV Rank (Implied Volatility Rank): A percentile ranking of current implied volatility compared to its historical range. Higher IV Rank suggests higher volatility relative to the past year.
• One by Two Ratio Spread: An options strategy involving buying one call (or put) option and selling two calls (or puts) at a higher strike price.
• Delta: A measure of an option's price sensitivity to a $1 change in the underlying asset's price.
• V Skew: The difference in implied volatility between options with different strike prices.
• USO (United States Oil Fund): An exchange-traded fund that tracks the price of West Texas Intermediate (WTI) crude oil.
• Implied Volatility (IV): The market's forecast of a likely movement in a security's price.
• Vertical Spread: An options strategy involving buying and selling options of the same type (calls or puts) with different strike prices but the same expiration date.

Oil Trade Strategy Utilizing a One by Two Ratio Spread

The discussion centers around a specific options trading strategy applied to USO (United States Oil Fund) due to current market conditions – specifically, a high IV Rank of 70% and expanding, despite a $1 price decrease in the underlying asset today. The trader acknowledges being a poor commodity trader and therefore employs a risk mitigation strategy.

Trade Setup and Details

The core of the strategy is a one by two ratio call spread. The trader is buying one 85 call option and selling two 95 call options. This results in a $10 wide vertical spread. The trade was initiated for a 72-cent credit (mid-price currently at 73 cents). The trader notes that wider spreads are difficult to achieve for a credit in a stock trading under $80.

The trade’s characteristics are as follows:

• Short Delta: Approximately 10. This means the trade will likely be filled if USO increases by roughly 10 cents, but not if it decreases by the same amount.
• IV Rank: 55 for the trade itself, with the overall USO IV Rank at 71% and expanding.
• Monthly Implied Volatility: 55.
• Break-Even Point: Above 105.

Rationale and Market Observations

The trader characterizes the trade as omnidirectional, but slightly bullish. However, the negative delta suggests a slightly bearish outlook. The rationale behind the trade is based on several observations:

1. Price Levels: USO is currently trading around 83, well below the long call strike of 85. The stock hasn’t exceeded 95 in a considerable time. This makes a significant price increase, necessary to reach profitability, less likely.
2. Volatility Contraction: The trader anticipates volatility will contract, particularly on the downside, as is typical for commodities. This contrasts with ETFs like SPY and QQQ, where volatility expands during price declines.
3. V Skew Exploitation: The trade aims to capitalize on the V skew – the difference in implied volatility between call and put options. The trader is leveraging the expectation that call volatility will decrease.

Commodity vs. ETF Volatility

A key distinction is made between commodity and ETF volatility. The trader explicitly states that commodity volatility expands on the way up, while ETF volatility expands on the way down. This is a crucial factor influencing the trade’s design. “It’s completely the opposite.”

Risk Management and Trade Characteristics

The strategy is presented as a high probability of success trade despite being directional in nature. The wide spread and the current price level of USO contribute to this perceived higher probability. The trader emphasizes the small directional exposure, framing it as a “tiny tiny tiny” bet. The long 85 call has approximately a 50 delta, indicating it requires a substantial move to become profitable.

Call to Action

The trader concludes with a promotional message, encouraging viewers to open, move, and transfer their accounts to Tasty Trade to support the continued production of free content on Tasty Live.

Synthesis/Conclusion

This trade exemplifies a risk-managed approach to options trading in a volatile commodity market. By employing a one by two ratio spread, the trader aims to profit from a potential decrease in implied volatility while limiting directional risk. The strategy is predicated on the expectation of range-bound trading in USO and leverages the unique volatility characteristics of commodities compared to traditional ETFs. The trade is designed for a high probability of success, albeit with a limited potential profit.