Watch Nick Battista Place a Live USO Diagonal Spread in 5 Minutes. Here's the Exact Setup.

Key Concepts

OVX (CBOE Oil Volatility Index): A VIX-style index measuring the implied volatility of oil futures.
Backwardation: A market condition where the spot price or front-month futures contract is higher than the back-month contracts.
Contango: The opposite of backwardation, where back-month contracts are more expensive than the front-month.
USO (United States Oil Fund): An ETF that tracks oil futures; it rebalances by selling front-month contracts and buying back-month contracts.
Diagonal Spread: An options strategy involving the purchase and sale of options with different strike prices and different expiration dates.
Positive Drift: A phenomenon in USO where the rebalancing process (selling high, buying low during backwardation) adds value to the fund.

1. Market Context and Volatility

The speaker highlights that oil volatility has been extreme due to geopolitical tensions involving Iran. To track this, the speaker uses OVX, which provides a gauge for implied volatility in oil futures. Because trading standard oil futures (/CL) involves a contract size of 1,000 barrels—resulting in a $1,000 move for every $1 change in price—the speaker opts for USO as a more manageable, smaller-product alternative for retail traders.

2. The Mechanics of USO and Market Structure

Rebalancing: USO holds a basket of oil futures. It must constantly roll its positions by selling the front-month contract and buying the back-month contract.
Backwardation vs. Contango:
- Typically, oil is in contango, where the back-month is more expensive, creating a "drag" on the ETF because the fund is forced to sell low and buy high.
- Currently, the market is in backwardation (front-month at ~$89, with back-months at $85, $82, etc.).
Positive Drift: Because the market is in backwardation, USO is currently selling higher-priced front-month contracts and buying lower-priced back-month contracts. This creates a "positive drift," which helps keep the ETF price elevated as long as oil prices remain high.

3. Strategy: The Diagonal Spread

The speaker proposes a diagonal spread as a cost-effective way to gain upside exposure to oil.

Methodology:
- Long Leg: Buy a call option with a further expiration (June) at a 40 delta (140 strike).
- Short Leg: Sell a call option with a nearer expiration (May) at a 20 delta (155 strike).
Risk Profile: This is described as a "gamma play" with high upside potential and limited capital risk. The position benefits from the positive drift of USO and the potential for the long option to hold value while the short option experiences time decay (theta).
Execution: The trade was executed for a $507 debit, which represents the total buying power required for the position.

4. Logical Connections and Rationale

The trade is predicated on two main factors:

Geopolitical Continuation: The assumption that the conflict with Iran will continue, keeping oil prices elevated.
Structural Advantage: The current backwardation in the oil futures curve provides a structural tailwind (positive drift) for the USO ETF, making it a superior vehicle for this specific long-bias trade compared to a standard long call.

5. Synthesis and Conclusion

The speaker concludes that the diagonal spread in USO is an efficient, low-cost speculative play. By leveraging the current backwardation in the oil market, the trader captures the "positive drift" of the ETF while managing risk through the sale of near-term, out-of-the-money calls. The strategy effectively balances the need for upside exposure with a defined risk profile, utilizing the specific mechanics of how USO rebalances its futures holdings.