Iran's Power Play Provides Options Play - TheStreet

Iran's Power Play Provides Options Play

Puts on oil futures are a way to profit from lower crude.
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Wall Street may have been misreading Tehran all along.

Oil prices fell Tuesday afternoon as signs that the likelihood of a diplomatic solution to tensions between Iran and Britain are increasing. Crude oil futures for May delivery fell $1.50 to $64.44 a barrel on the New York Mercantile Exchange after conciliatory statements by Iranian officials hinted that the oil-rich gulf state may be changing its posture.

Still, crude oil futures were trading below $60 only two weeks ago, before Iran captured 15 British sailors for allegedly trespassing into Iranian waters. If the situation is resolved, oil may well fall to where it was trading before the current incident ensued. This could provide investors willing to see past Iran's chest-thumping with a chance to book a quick, tidy profit.

While many observers have interpreted the angry rhetoric as a sign of an impending brawl, what may actually be taking place is a carefully considered power play.

"This is a scripted and planned move on Iran's part," says Peter Zeihan, director of global analysis for Stratfor, a research firm that specializes in intelligence matters. "And while it is widely perceived as a crisis, it is not considered a crisis in Whitehall

Britain's governmental street or the White House."

Iran's moves are intended to give it an eventual edge in talks with the U.S. and a way to check the power of Iraq down the road, Zeihan says. Iran and Iraq have a history of hostile relations between them, and Iran will seek to minimize the amount of military hardware the U.S. provides Iraq.

The latest round of muscle-flexing is a way for Iran to remind the U.S. and Britain about the influence it wields in the region, and that it would maintain its aggressive posture despite threats of UN sanctions.

Capturing the British prisoners also gives Iran a quick way to score points at home. "Putting detainees on television and parading them around is a very effective way to get a nice nationalist response," Zeihan says. "The entire point is to give the Americans and the British a feeling of losing control."

A sign that markets may be misreading Iran's grandstanding and effort to score cheap publicity points at home took place on Friday, when oil futures spiked more than $5 on rumors that Iran had fired a missile at U.S. warships.

It's telling that investors were so willing to believe Iran would engage in such openly hostile behavior that would very likely elicit a military response. It flies in the face of the view that this incident has instead been a carefully choreographed publicity stunt. Iran has taken pains to ensure that its rendition of events is legally consistent by insisting that the British sailors were in Iranian territory.

But it would be hard to portray a shot at a U.S. ship as anything short of an act of war.

Also, Britain's stance via private diplomatic channels may be more accommodating than its public position. Britain has insisted that its sailors were in Iraqi waters as part of a U.N. mandate. It wouldn't negotiate with Iran and demanded the unconditional release of the detainees. Then on Monday evening, anonymous British officials told news organizations that Britain was receptive to talking to Iran about ways to avoid future maritime disputes.

But if the sailors were squarely in Iraqi waters, there would be little to talk about. Instead, the British seem to be compromising without officially changing their stance -- with the goal of seeing the detainees set free. That stance could further help bring crude futures down.

Keep in mind this isn't the first time that Iranian showboating and saber-rattling has caused the price of oil to shoot up. Just last April, Iran test-fired missiles over the Strait of Hormuz, causing oil to soar over $70 a barrel as commentators laid out nightmare scenarios.

Fortune

ran an article titled "Ready for $262 a Barrel Oil?"

Instead, oil was down to the low $60s by October once tensions subsided.

Taking a short position on crude futures may be too risky as the situation always has the potential to spin out of control. "Things could change completely in a minute," Zeihan notes.

But purchasing put options on crude futures contracts -- which would give investors the right to sell at a given price and pocket the difference -- warrants a closer look.

May delivery put options for crude oil at $63 were trading at $1.02 on the New York Mercantile Exchange as of Tuesday afternoon, says Edward O'Connor, the president of Optionable, an electronic exchange that focuses on energy futures. Investing in those options would give investors a way to book a profit if the situation settles and prices revert to where they were before it started.

And if things take an ugly turn that sends the price of oil soaring, investors can limit their exposure to the cost of the options and simply let them expire.

The value of the options also would increase if crude oil prices continue to come down. In fact, the value has already increased from 66 cents on Monday.

Options may be the best -- and safest -- way for investors who think concerns over the current situation in Iran are overblown.